Pfi

[Snoopy]

Let's line up the 'what actually happened table' against the 'what would have happened table' and see what the differences might have been.

The 'what actually happened table' includes FY2018 and FY2019, two years where the depreciation allowance on buildings was not allowed to be claimed. Yet there was still some depreciation allowed for in the accounts. It appears from this quote from AR2022 p73 that this 'residual depreciation' may be from the building fit out.
"The calculation of deferred tax on depreciation recovered places reliance on the land and building split in the valuation provided by the valuers. The building value is then split between fit-out and structure based on the proportion of the tax book values of each."

So under a new 'building depreciation is no longer tax deductible' regime, 'building fit out' items, like movable interior divisions and air conditioning systems, would still be tax deductible, even if the structural elements of the building were not. To reflect this element, I am going to assume that even with building depreciation disallowed in our hypothetical FY2020-FY2022 alternative 'what would have happened' scenario (i.e. where there is no 'building depreciation' in any year), there would be a residual annual depreciation charge of $9.300m (my estimate, as used in the first table below in calculations, note 3) that would remain.

What actually happened

i/ Building Depreciation Allowed FY2020,FY2021,FY2022	FY2018	FY2019	FY2020	FY2021	FY2022	Total
Profit before other expense/income and income tax (as declared)	$89.816m	$96.109m	$97.395m	$108.655m	$110.921m
less Depreciation Allowance (1)	$9.357m	$9.279m	$15.854m	$17.561m	$20.836m
less Property Costs	$12.507m	$14.850m	$16.262m	$16.753m	$17.598m
less Interest Expenses & Bank Fees	$18.766m	$19.008m	$18.233m	$20.106m	$24.638m
less Administrative Expenses	$4.679m	$5.072m	$5.851m	$7.465m	$8.508m
equals IRD Profit before other expense/income and income tax {A}	$44.507m	$47.900m	$41.195m	$46.770m	$39.341m
less Income Tax expense @ 28% (this calculated scenario) (2)	$12.462m	$13.412m	$11.535m	$13.096m	$11.015m	$61.520m
equals IRD Operational Net Profit After Tax	$32.045m	$34.488m	$29.660m	$33.674m	$28.326m
add Cashflow from 'Structural Depreciation' not reinvested (3)	$0m	$0m	$6.554m	$8.261m	$11.536m
equals 'Cash Earnings' available for distribution	$32.045m	$34.488m	$36.514m	$41.935m	$39.962m
(Reference Only) Current tax expense (AR Note 5.2 'Tax')	$8.886m	$13.106m	$10.066m	$10.605m	$10.525m	$53.188m

Notes

1/ The annual depreciation charge is not even stated in the respective annual report(s). But we can work out what it is by looking at the notes from the AR section 5.2 on tax. There is a note there that discloses various factors in the prima-facie reduction to income tax, of which one ingredient is 'depreciation'. To get the actual depreciation charge for any year from this 'adjustment' figure, you have to divide this 'depreciation ingredient' figure by the company tax rate of 0.28. As an example, the depreciation charge for FY2022 was: $5.834m/0.28 = $20.836m. If we include these depreciation charges in the profit results, a very different - but more believable - picture of profitability to that reported in the annual result(s) emerges.

2/ For the purpose of this exercise I have used the legislated company tax rate of 28%, when I calculate 'income tax expense'. I have done this because I believe it is the best way to look at the 'change in profitability' between the two scenarios that I am about to outline in detail. I don't fully understand how the exact dollars of tax are calculated in the published accounts. So it makes no sense to try and replicate a calculation process that I do not fully understand. Better to take a calculation method I do understand, and record the tax differences from two alternative sets of input assumptions.

3/ The figure I have used of $9.300m for the depreciation of 'building fittings' is an eyeball average of the actual figures used in FY2018 ($9.357m) and FY2019 ($9.279m), two reporting periods where this figure was known definitively. I use this figure to calculate the structural depreciation that does not have to be, which can therefore go towards adding to the declared dividend.
3a/ Calculation for FY2020: ($15.854 - $9.300)m = $6.554m
3b/ Calculation for FY2021: ($17.561 - $9.300)m = $8.261m
3c/ Calculation for FY2022: ($20.836 - $9.300)m = $11.536m



What would have happened

In the alternative legislative scenario below, where depreciation from buildings is no longer allowed to be offset against profits, the subset of 'structural depreciation' switches from being 'a tax deductible expense' to a disallowed charge. This will increase the declared profit of the business, and consequently increase the government's income tax take (+$7.379m over three years, a $7.379m/$35.646m= a 20.7% rise).

ii/ If Building Depreciation DisAllowed	FY2018	FY2019	FY2020	FY2021	FY2022	Total
Profit before other expense/income and income tax (as declared)	$89.816m	$96.109m	$97.395m	$108.655m	$110.921m
less Depreciation Allowance (scenario for FY2020-FY2022)	$9.357m	$9.279m	$9.300m	$9.300m	$9.300m
less summed Property, Administration and Interest Costs	$35.952m	$38.930m	$40.346m	$44.324m	$50.744m
equals IRD Profit before other expense/income and income tax {A}	$44.507m	$47.900m	$47.749m	$55.031m	$50.877m
less Income Tax expense @ 28% (this calculated scenario)	$12.462m	$13.412m	$13.370m	$15.409m	$14.246m	$68.899m
equals IRD Operational Net Profit After Tax	$32.045m	$34.488m	$34.379m	$39.622m	$36.631m

This is the point where removing building depreciation as a tax deductible asset starts to do my head in. It is quite clear when comparing the two tables that IRD recognized profit has gone up, with the removal of building depreciation deductability. It is also clear that the income tax paid to the government has gone up (which would be the whole point of the touted government tax law change: Rich building owners would pay more tax, to pay for tax cuts to the 'squeezed middle'). So the way I see things, dividends to unit holders should now increase because the profits to unit holders have increased. But this is only true if all of the past situation dividends are sourced from earnings. And as we have now learned (refer forwards to post 30) not all of the past dividends have come from earnings!

The counter argument to all of this is that -actually- buildings still do depreciate over time. So when the time comes around for the building to be re-clad (or whatever), then PFI will be required to front up with 'new capital' to do the re-cladding. But under the old regime, where depreciation was allowed, no 'new capital' would be needed, because the 'tax not paid' (the tax paid under the old regime was lower because of lower profits with building depreciation allowed) could be used to refurbish the building without budgeting to put in 'new capital' for the refurbishment. So where will this 'new capital' come from? By reducing the dividend in the future of course (one way of raising it)!
Yet all this 're-cladding' (as an example) could be many years away. In the meantime, the more tax the company pays, the better off unit holders are, because the company is making more profit and paying the extra tax on potentially higher dividends on the unit holders behalf!!?!!

Have I got that logic right? Help me out here.....
(Addendum 15-01-2023: One thing that was missing from this argument is that the cashflow from building structure depreciation, which is not earnings, was nevertheless being added to the dividend. This was prior to any 'change in law' that might see structural depreciation on buildings disallowed as a tax deductible expense)

SNOOPY