Costs incurred in relation to zoning changes involved in the conversion of land for the purposes of property development projects could be deducted on a one-off basis on the date they were incurred.
The case involved a company planning to expand its landfill site for the purposes of its business activity. The taxpayer explained that the investment project required a reclassification of the land where the landfill was to be located. The reclassification procedure involves the payment of fees for excluding lands from forest or agricultural production and a one-off compensation fee for premature tree felling. The company asked whether costs incurred in relation to zoning changes involved in the conversion of land for the purposes of its property development project could be included in its tax deductible costs.
The tax office said yes. It specified, however, that the expenses concerned should be classified as indirect costs, as they were not reflected in the company’s revenues directly, even though they were clearly incurred in relation to its general business activity and revenues. Consequently, they should be recognised as tax deductible costs in the year in which they were incurred pursuant to Article 15 Sections 4d and 4e of the CIT Act.
The company was not satisfied with this reply. In its appeal it argued that the date on which indirect tax deductible costs were recognised depended on such expense being recognised as a cost within the meaning of balance sheet law. In addition, the company also challenged the conclusion that costs incurred in relation to zoning changes involving the conversion of land for the purposes of its property development project should be recognised as tax-deductible costs through depreciation write-offs.
Dismissing the cassation appeal filed by the tax office, the Supreme Administrative Court pointed out that the office had apparently disregarded the already established case-law of administrative courts with respect to the accrual or cash-based cost accounting principle. In its opinion, the Provincial Administrative Court correctly assumed that since all events occurring during the reporting periods were to be disclosed in the books in the chronological order in which they actually occurred, the date of posting a particular invoice (expense) should be deemed as the date on which the relevant cost was incurred. Costs related directly to the generation of revenue are deducted from revenues for the year concerned (the year in which the revenue was generated), and indirect costs are deducted in the year in which they were incurred. The term “cost” itself is used within the meaning of the Tax Act. It is therefore incorrect to use it in a different context, resulting from the provisions of the Accounting Act. The Supreme Administrative Court emphasised that the actual date under which an expense is entered in the accounting books cannot alter the classification of such expense, or affect the time when it is recognized as a cost within the meaning of Article 15 Section 4e of the CIT Act.
The Court concluded that expenses such as those referred to in the enquiry filed by the company could be deducted on a one-off basis on the date on which they were incurred, as defined by Article 15 Section 4e of the CIT Act, i.e. the date on which the cost was posted in the books based on the relevant invoice as a liability towards the counterparty. On the condition, of course, that – due to their nature – they cannot be linked to a period longer than the financial year, and it is not possible to determine what portion of such expenses applies to a particular financial year pursuant to tax regulations.
Supreme Administrative Court ruling of 22 March 2016 (II FSK 687/14).
Expert’s comment
The ruling discussed above coincides in principle with the established case-law on accounting for the so-called indirect costs over time, which says that indirect costs should be recognized on a one-off basis on the date on which the invoice is posted in the system.
Pursuant to Article 15 Section 4e and 4d of the CIT Act, costs other than those directly related to revenues should be deducted “on the date they are incurred”, i.e. on the date “on which the cost is posted in the accounting books”. In fact, this provision has given rise to doubts from the very beginning, mostly due to the terms it uses which typically appear in accounting and not in tax regulations. For example, it refers to the posting of costs, and not of expenses, liabilities or invoices. Furthermore, the wording of this regulation is different from its counterpart in Article 22 Section 6b of the PIT Act. This results in the belief, widespread among taxpayers, that it refers not to the date of posting the invoice (the date of the invoice, or the date on which it is entered in the system as a liability), but the date on which the invoice is recognised as a cost item in the profit and loss account. Such interpretation would have certain advantages (as it would reduce the difference between the accounting and the tax result), but also the disadvantage of resulting in a higher tax liability due to the reduced amount of tax-deductible costs recognised on an on-going basis despite the fact an expense was actually incurred (payment was made). For this reason, the courts’ opinion should be concurred with. If a taxpayer is interested in posting indirect costs separately for the purpose of reconciling the tax and the accounting result, there is, in fact, no particular reason why they should be posted in accordance with accounting principles for tax purposes. Such interpretation, however, exposes entrepreneurs who do not take such corrections into account in their reconciliation (e.g. international corporations or financial institutions for which this could be convenient) to the risk of being charged with overstating their tax-deductible costs in subsequent financial years.