Investing in Property, Plant, and Equipment (PPE) is generally a good indication of growth for many businesses. PPE assets represent a fairly large investment with future economic benefits for most companies. While we are just a few months away from filing season, it is high time that we review our treatment of property, plant. and equipment, both for tax and accounting purposes.
PPE BY DEFINITION
International Accounting Standard (IAS) 16, the standard that prescribes the accounting treatment for PPE, defines property, plant, and equipment as tangible items that are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes and that are expected to be used during more than one period. As such, PPE represents important assets necessary for any business operations.
Typical examples of PPE are buildings, equipment, machinery, transportation vehicles, land, furniture, and fixtures that are used in the business.
For accounting purposes, an item of PPE that qualifies for recognition as an asset is initially measured according to its cost, which includes the actual purchase cost and those expenditures that are ordinary and necessary to bring the asset in place and in condition for its intended use, such as: its purchase price, including import duties, nonrefundable purchase taxes, after deducting trade discounts and rebates; any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management (e.g., costs of site preparation, professional fees, initial delivery and handling, installation and assembly, etc.); and the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located.
Many expenditures for long-lived assets will surely benefit a business for a certain period. The question is: should these expenditures be capitalized or depreciated over their useful life? For tax purposes, PPE acquisitions should be capitalized over the useful life of the asset that substantially extends beyond the year. The useful life of an asset is usually determined by the taxpayer. However, the initial estimate of the costs of dismantling and removing the item and restoring the site is not part of the cost for tax purposes.
Under IAS 16, PPE is carried either at cost or at revalued amounts, less accumulated depreciation and impairment losses. There should be a reasonable allowance for depreciation to be deducted from gross income. With the fixed asset’s cost as the basis for depreciation, any adjustment due to impairment should not be included for tax purposes.
PPE declines in value over time. Depreciation is the process of allocating the cost of the asset over its useful life to account for a reasonable amount of exhaustion, wear, and tear of the property used in business. It represents how much the value of the asset has been used up. In general, businesses can depreciate assets both for tax and accounting purposes.
A reasonable allowance for depreciable asset is generally allowed under existing tax rules. However, no depreciation deduction will be allowed in the case of property that has been amortized to scrap value and is no longer in use.
There are many types of depreciation, such as the straight-line method and accelerated methods. Existing tax rules prescribe depreciation methods that the taxpayer may choose from, but it will depend on the experience of the taxpayer in determining the method of depreciating the asset. However, should there be any change in the depreciation method used in the business, approval from the Bureau of Internal Revenue (BIR) is needed.
LIMITATION ON DEPRECIATION EXPENSE
Under Revenue Regulations (RR) No. 12-2012, the BIR imposed a limit on the deductibility of depreciation allowance, maintenance expenses, and input value-added tax on motor vehicles as follows: substantiation of the purchase with sufficient evidence, such as with official receipts and other records indicating the price, motor vehicle identification number, chassis number, etc.; the taxpayer has to prove the direct connection of the motor vehicle to the business; one vehicle for land transport is allowed for the use of an official or employee with a value not exceeding P2.4 million; with no depreciation allowed for yachts, helicopters, airplanes, and land vehicles with a value over P2.4 million, unless the vehicle is used in the company’s transport operations or represents a lease of transport equipment.
DERECOGNITION OF PROPERTY
When no future economic benefits are expected from the use or disposal of the PPE, it is derecognized. The gain or loss arising from the derecognition of an item of PPE shall be included in the profit or loss when the item is derecognized. On the other hand, there are certain conditions to be complied with before this is allowed as a deduction for tax purposes.
While property, plant, and equipment are considered vitals component to business operations, this item on the balance sheet should not be taken for granted. It is important that investment and expenditure in PPE are properly monitored, as this signals profitability, responsibility, and taxability.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
Maricel P. Katigbak is a manager of Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.