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Large-scale project planning – the construction of a logistics centre

Financing – Accounting – Taxation (Part II – Lease accounting, equity ratio and particular tax aspects)

When planning large-scale projects – such as the construction of a logistics centre -, besides structural engineering and logistical aspects etc., other fundamental matters can arise, for example, the financing of the project, questions about the accounting or also tax issues. After providing a short overview of alternative possible forms of financing and outlining the basic recognition and measurement issues for the financial accounts in Part I of our report, now, in Part II, we discuss the special features in cases of leasing, the impact on the equity ratio as well as the particular tax aspects.

Accounting aspects in cases of leasing

Attribution – the key issue for the financial and tax accounts

Under German accounting law (under both the Commercial Code [Handelsgesetzbuch, HGB] as well as under tax law) the key question in lease accounting is normally: to whom is the leased asset (economically) attributable – the lessor or the lessee? The answer to this question determines the further legal consequences, in particular, who has to recognise the leased asset. Here, the so-called leasing decrees issued by the German fiscal administration play a major role in the lease accounting assessment.

Special lease model in the case of the construction of a logistics centre

Given that a – yet to be built – logistics centre is generally very specifically tailored to the needs of the (future) lessee and that it would only be appropriate for them and that, normally, it is scarcely likely that there would be any other possible economically viable use for or exploitation of the building, in such cases, a so-called special lease model applies. Consequently, the economic ownership of the leased asset – so, here, the logistics centre – would generally have to be attributed to the lessee irrespective of any questions about the basic lease term, or something similar. However, there are exceptions here in the case of land. Here, depending on the specific leasing arrangement, it would be necessary to determine separately in each case, on the basis of the leasing decree of 21.3.1972, whether the land should be recognised by the lessor or the lessee. 

If the lessee, as the economic owner of the logistics centre has to recognise its acquisition and construction costs (the starting point for this would be the lessor’s acquisition and construction costs that were used as the basis for the calculation of the lease payments) then the lessee would likewise have to recognise the corresponding liability to the lessor. 

No special lease model

If the situation does not warrant the special lease model – for example, if the logistics centre is not tailored to the particular needs of the lessee -, then it would be necessary to check, on the basis of the contractual arrangements, whether for reporting purposes the logistics centre in question should be attributed to the lessor or to the lessee. To this end, important criteria for the attribution to the lessee are, in particular:

  • the ratio of the basic lease term to the average operating life (as the leasing decree specifies that for buildings this is generally a period of 50 years) and 
  • the presence of and arrangements for options to purchase and extend the lease.

If, as in the case of a special lease, the leased asset has to be attributed to the lessee then the lease payments that are made would have to be divided up in the lessee’s financial accounts into the interest and principal components and the logistics centre would also have to be recognised by the lessee.

Sale-and-lease-back – a special case

If the contract arrangements have been selected so that the lessee remains the economic owner – this is normally the case with sale-and-lease-back – then the leased asset will remain continuously with the lessee. In such cases, a transfer of the leased asset to the financial accounts of the lessor and then back again to those of the lessee does not take place. The lease payments then have to be regarded as pure financing and reported under the other liabilities item. The lease payments made by the lessee have to be divided up into the principal and interest components.

IFRS Accounting

In accounts prepared according to IFRS the lease accounting is determined by IFRS 16. Lessees now no longer need to divide up their leases into operating and finance leases, as previously under IAS 17; moreover the question of the attribution of the asset – such an important one under German accounting law – does not arise here. Instead, at the commencement of the term of the lease agreement, the lessee has to recognise or report the right of use as well as the lease liability. The starting point for the recognition or measurement of the right of use and the lease liability, in each case, is the present value of the lease payments. 

With regards to the subsequent measurement, in terms of the lease liability it will be necessary to split the regular payments into the interest and principal components. The right of use has to be amortised like a ‘normal’ fixed asset on a scheduled basis and (if necessary) on an unscheduled basis.

Impact of the form of financing on the equity ratio

In terms of the financial reporting for a logistics centre construction project, especially when selecting an appropriate type of financing, it is also necessary to focus on the consequences for the equity ratio since, in individual cases, this could play an important role in the context of financial covenants, for instance. By way of example, four cases can be mentioned here:

  • insofar as the project is financed by accumulated earnings (non-debt financing in the form of internal financing) then this will not affect the equity ratio because, in this case, financial resources would simply be redeployed into tangible fixed assets (logistics centre) on the asset side of the balance sheet (so-called accounting exchange on the assets side).
  • Insofar as the non-debt financing occurs via an inflow of new funds from outside (via capital contributions from partners/shareholders or from capital increases) this would generally mean that the equity ratio would be strengthened.
  • By contrast, financing via a bank loan would push down the equity ratio because there would then be more debt in relation to equity. 
  • Given that in lease accounting – under both German accounting law, where it is assumed that the lessee is the economic owner, as well as under IFRS –, the liability to the lessor has to be recognised, the equity ratio will likewise contract in the event of lease financing.

Please note: In practice, it is not uncommon here to choose structures to sidestep this; these involve transferring capital goods to so called special purpose vehicles (SPVs). One of the purposes is that these companies are structured in such a way that they do not have to be included in the consolidated financial statements and, therefore, do not affect the equity ratio there. 

Tax aspects

For reasons of complexity, the tax aspects discussed below are limited solely to issues related to tax on earnings.

Impact of depreciation on tax on earnings

From the perspective of tax on earnings it must be noted that the main ramifications in this respect will already be apparent once the type of financing has been selected and, consequently, also those for the (tax) accounting treatment, such as, for example: 

  • the distinction between the components of a building and the operating equipment, 
  • the capitalisation of interest that arises during the construction period of an asset, 
  • the size of the leasing payments or amount of depreciation and
  • the financing interest.

The only way the capitalised costs of the capital asset are able to have the effect of reducing the tax liability is normally via scheduled depreciation. While land (and thus also the ancillary costs of acquisition, such as real estate transfer tax) cannot actually be depreciated on a scheduled basis, a building is normally depreciated over a period of 33.3 years for tax purposes. It is only capitalised operating equipment that can usually be depreciated over a shorter period of time. 

If the capital asset appears on the balance sheet of the finance provider (e.g., in the case of a lease this would be the lessor) then the leasing payments can generally be immediately deducted, as business expenses, from the assessment base for the tax on earnings (please see below for particularities in the case of trade tax).

Option with respect to the recognition of financing interest.

Financing interest generally lowers the tax assessment base and thus the tax burden if, in the financial accounts and in the tax accounts, it has not been exceptionally capitalised as construction costs (option), insofar as this was permissible. The option would have to be exercised consistently in both the financial accounts and in the tax accounts because of the German principle of Maßgeblichkeit [under which financial accounting leads tax] (cf. margin no. 6 of the Federal Ministry of Finance circular of 12.3.2010). 

Recommendation: The capitalisation of the interest that arises during the construction period of an asset may, in specific cases, be an attractive option, in particular, with regards to avoiding the pro-rata add-back of interest expenses that would otherwise be incurred in the context of trade tax (ultimately a neutralising effect) and temporarily strengthening the equity ratio. 

Financing interest, just as the interest component contained in lease payments, has to be partially added back again to increase profits in off-balance-sheet accounts for trade tax purposes. However, if the option is exercised and the interest that arises during the construction period is capitalised then, for trade tax purposes, it does not have to be partially added back again to profits either in the year when it is capitalised or in the years when it has an impact on profits via amortisation. 

Please note: For the sake of completeness, it should also be noted that depending on the size of the business or of the interest expense the so-called interest barrier (Section 4h of the German Income Tax Act) could potentially result in a limitation on the deductible amount (at least temporarily).

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