PRC Land Appreciation Tax falls within the scope of HKAS 12 Income Taxes

In its September 2007 meeting, the Financial Reporting Standard Committee (FRSC) of the Hong Kong Institute of Certified Public Accountants considered and accepted the conclusion reached by its Working Group on PRC Land Appreciation Tax (PRC LAT), that the tax is a form of income tax and therefore falls within the scope of Hong Kong Accounting Standard 12 (HKAS 12) Income Taxes.

Background of PRC LAT and current practice
The PRC LAT applies when a transfer of PRC land use rights, buildings thereon or facilities attached thereto takes place, and the transferor receives a consideration for the transfer. According to the law, the PRC LAT is levied on the net transfer proceeds after allowable deductions. Deductions include the cost of land use rights and development expenses.

In the past, local tax bureau had the practice of collecting the tax based on a percentage of the gross sales proceeds as a prepayment. According to the law, when certain conditions are met (e.g. the property development project is complete), a final assessment should be made based on the net sales proceeds. However, it was not uncommon for some property developers to defer the final assessment and payment of the balance by retaining a small number of units unsold.

Because of the collection mechanism, the PRC LAT appears to some to be a tax on sales. In addition, LAT paid is a deductible expense for PRC Corporate Income Tax (PRC CIT) purposes and is also required to be recorded as "cost of sales" according to the Chinese Accounting Standards. There has been confusion as to whether the tax is income tax or sales tax. As a result, the PRC LAT is sometimes presented as "cost of sales" and sometimes as "income tax" in the financial statements of property developers and property investors.

Since the final assessment and collection of the tax balance could in practice be delayed for an indefinite period, some entities have made provision based on the expected amount to be paid (partial provision) whereas other entities have made full provision according to the tax law (full provision).

In December 2006, Guo Shui Fa No.187 was issued to reinforce that, when conditions are met, taxpayers are responsible for submitting the relevant documents for final assessment and tax bureau have the authority to demand taxpayers to undergo the final assessment.

Basis for conclusion
As noted in the FRSC Meeting Summary - September 2007, the Working Group concluded that the PRC LAT is a form of income tax and is within the scope of HKAS 12.

Accounting treatments
Current tax for current and prior periods shall, to the extent unpaid, be recognised as a liability (HKAS 12.12). This leads to the question of when the PRC LAT liability, a form of current tax, crystallises. Article 10 of the Provisional Regulations of the People's Republic of China on Land Appreciation Tax (State Council: 13 December 1993) states that taxpayers shall report their tax liability to their local tax bureau within seven days of signing the real estate transfer agreement for an individual unit, and pay the tax within the period specified by the local tax bureau.

If a property developer is granted approval by local tax bureau for their tax liability relating to the transfer/sales of units of real estate within a property development project, to be considered on a project basis rather than per each individual unit, in our view, the PRC LAT should be provided as current tax liability, at the earlier of:

HKAS 12.46 states that "current tax liabilities (assets) for the current and prior periods shall be measured at the amount expected to be paid to (recovered from) the taxation authorities using the tax rates (and tax laws) that have been enacted or substantially enacted by the balance sheet date." (with emphasis added). Based on this paragraph, the amount of tax provision should be based on the best estimate of the net sales proceeds of the development project and the estimated applicable tax rate (i.e. full provision). Any tax paid before this point of time is recognised as tax prepayment. Tax paid after the recognition of this current tax liability is recognised as a reduction of the current tax liability.

The corresponding debit entry for recognising the current tax liability is an expense or a current tax asset depending on when the revenue from the sale of the real estate is recognised. The expected common situation is that revenue recognition takes place before the PRC LAT first arises. In our view, the matching PRC LAT should be estimated and recognised even though the PRC LAT triggering event under Article 2 of Guo Shui Fa No.187 has not happened. This results in recognition of income tax in the income statement and current tax liability in the balance sheet.

If any one of the conditions set out in Article 2 of Guo Shui Fa No.187 applies (i.e. the PRC LAT liability first arises) before the revenue recognition of real estate sales, the debit entry corresponding to the tax liability is a current tax asset. This current tax asset is released to the income statement to match the revenue recognition in subsequent periods.

These accounting treatments are appropriate provided that the property developer is granted approval by tax bureau for the PRC LAT to be applied and administered on a development project basis. If there is any doubt on the interpretation of the tax laws, legal advice should be obtained.

Action now
This FRSC clarification is expected to eliminate the divergence in the classification of the PRC LAT in income statement of property developers and property investors. We recommend that entities subject to the PRC LAT review their accounting policies. Examples of the matters to be considered in the course of this review are listed below:
 

	The applicable tax rate
	Income tax is calculated at the tax rate that is expected to be applicable when the tax is payable. The PRC LAT is levied at progressive rates which are determined by the total net sale proceeds of the property development project. Management should make a best estimate of the appropriate tax rate and perform a review of the rate in each subsequent period until the final tax rate is agreed by the tax bureau.
	Deferred taxation
	The PRC LAT is a deductible expense under the PRC CIT. If any PRC LAT is recognised in profit or loss, but is included in the PRC CIT computation in a subsequent period, this will result in a temporary difference and the related deferred tax asset should be recognised according to HKAS 12.
	Application of the new accounting treatments
	The change in financial statement presentation and change in provisioning policy for PRC LAT should be applied consistently for all periods presented in the financial statements. Comparatives should be restated if the effects are material.

fanny.hsiang@gthk.com.hk

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