Suspension of fixed assets depreciation

Within the many provisions issued to deal with the crisis generated by the COVID-19 pandemic to companies, the Italian legislator also dealt with the impacts of the crisis on the recording of financial statements values (e.g. the worsening of economic and financial ratings, or the incidence on shareholders’ equity losses).

The “Rilancio” Decree (conversion law no. 77/2020) already introduced a mechanism for the evaluation of the going concern with regard to financial statements values in order to avoid that the application of ordinary accounting criteria for the preparation of the financial statements could lead to the termination of a company’s activity in the exceptional context of the Covid-19 crisis.

The “August” Decree dated 14 August 2020, no. 104, as amended by its conversion law dated 13 October 2020, no. 126, again assuming that the exceptional current period could not be correctly interpreted under the ordinary financial statements preparation rules, introduced two measures aimed at mitigating the negative effects in the financial statements, i.e.: the extraordinary revaluation of tangible and intangible assets and of company’s shareholdings (art.110) – analysed in one of our Clever Desk Alerts – and the suspension of the depreciation of tangible and intangible fixed assets (art. 60, para- 7-bis to 7-quinquies).

This article analyses the latter measure, also in consideration of the clarifications provided in Assonime circular letter no. 2 dated 11 February 2021 and of the opinion expressed by the Italian accounting standard setter in its draft interpretation document (OIC interpretation document no. 9), which examined the many issues that are still under discussion concerning this exceptional provision.

With reference to the suspension of depreciations, conversion law no. 126/2020 introduced under art. 60 of the August Decree, the abovementioned paragraphs 7-bis to 7-quinquies, providing that non-IAS adopters can suspend up to 100% of the depreciation of the annual cost of tangible and intangible assets.

In this way, the suspended depreciation charge will be imputed to the income statement of the following fiscal year, thus extending the depreciation plan by one year. Subjects benefitting from this suspension must allocate to a restricted reserve profits whose amount is equal to the suspended depreciation charge, while the explanatory notes must contain an explanation of the reasons underlying this suspension, the allocation of the reserve and its impact on the representation of the assets and financial situation as well as of the result for the year.

This regulation, which certainly generates some doubts from an accounting perspective – considering that companies are given the possibility to exclude from the financial statements a cost that is pertaining to the FY – represents an additional possibility compared to that already provided under art. 2426 of the Italian Civil Code, allowing the amendment of depreciation criteria and of applied coefficients, to be explained and justified in the explanatory notes.

1. Scope of application

As mentioned above, the regulation under analysis concerns all companies that do not apply international accounting standards. Therefore, these include companies that prepare their financial statements under OIC accounting standards, non-IFRS adopting intermediaries applying the rules under legislative decree no. 136/2015 and insurance companies that do not adopt international accounting standards.

According to Assonime, the regulation also concerns those companies classified as “micro-enterprises” pursuant to art. 2435-ter of the Italian Civil Code – which apply a simplified scheme for the preparation of financial statements, which does not provide the explanatory notes – due to the fact that the information requirements for such companies can be shown at the end of the balance sheet.

The regulation expressly provides that the possibility to suspend depreciations is applicable to the FY being current at the effective date of the decree, i.e. to fiscal years being current at 15 August 2020 (e.g. financial statements at 31 December 2020). Considering the evolution of the economic situation due to the Covid-19 pandemic, the legislator also provides the possibility to extend this measures also to following FYs through the issue of a proper Decree by the Ministry of Economy and Finance.

A particular consideration is needed with regard to consolidated financial statements. In fact, the following situations can occur: all companies included in the consolidation benefitted from the suspension; only the consolidating company benefitted from the suspension; some or all of the consolidated companies benefitted from the suspension.

To this regard, reference is made to OIC interpretation document no. 9, according to which the possibility to suspend depreciations could apply also to companies preparing the consolidated financial statements in compliance with Legislative Decree no. 127/1991. In particular, it specifies that the provision apply to the consolidated financial statements of the ultimate parent company, also in case it did not benefit from the suspension in its own financial statements.

In such a situation, the consolidated financial statements includes the effects of the suspension only with reference to the consolidated companies which benefitted from the suspension. The suspension allows the application of non-homogeneous evaluation criteria. In practical terms, when preparing the consolidated financial statements, add-backs of values of the single consolidated companies can be made as they are shown in their respective financial statements, thus without making any adjustment to unify evaluation criteria.

With regard to concerned assets, the provision, in general terms, applies to tangible and intangible assets, including goodwill, meant as that share of the acquisition cost of a company or of a business unit, which cannot be attributed to single assets. Although it is not represented by a legally protected asset – despite being an intangible asset – according to Assonime, goodwill should certainly be concerned by the provision under analysis.

Start-up and development costs must be considered in a similar way. Moreover, being this a general favourable regulation, the suspension concerns also goods acquired in the FY whose paid amount is recovered at the end of the depreciation plan rather than in the following FY.

OIC interpretation document no. 9 also discusses whether the suspension of depreciations must necessarily concern whole classes of intangibles or it can applied also to single assets. Considered that the suspension is based on different types of justifications, which can also concern single assets, it should be possible to apply the suspension to single assets, to groups of assets or to the whole category. The only warning is that the choice of the eligible assets must be consistent with the reasons that led the company to suspend depreciations.

2. Application procedure of the depreciation suspension

Art. 2426, para. 1, n.2) of the Italian Civil Code provides that the cost of tangible and intangible assets, whose use is limited in time, must be systematically depreciated in any fiscal year based on their residual possibility of use.

Compared to the above article, art. 60, para. 7-bis to 7-quater of the August Decree introduced the suspension of depreciations and the extension of the original depreciation plan by one year.

The rule provides that the company can suspend up to 100% of the annual depreciation of the assets cost, maintaining the registration value as it results from the last duly approved financial statements.

Considering the above, the suspension of the depreciation must not necessarily be total, but rather it can be a reduction of the annual charge provided by the original depreciation plan also by a percentage lower than 100%.

A particular consideration must be made on the criterion used to suspend the depreciation of assets (the company must explain in the notes the reasons underlying the choice to apply the suspension of depreciations). In fact, the suspension of depreciations can be justified in all cases where single assets or categories of assets are not used or are less used, but also when it derives, more generally, from the negative economic effects of the COVID-19 pandemic.

3. Extension of the depreciation plan

The regulation provides that the suspended depreciation is entered in the income statements of the following FY. The depreciation charges of following FYs are postponed following the same criterion, thus extending the original depreciation plan by one year.

If the lower depreciation is not associated with an extension of the asset useful life due to, for example, contractual or technical obligations, the extension of the depreciation plan by one year cannot be considered as an automatic effect of the application of the suspension under analysis, but it rather derives from the concrete evaluation of the actual extension of the concerned asset operated by the company compared to the original depreciation plan. 
 

4. Restricted reserve

Those companies benefitting from the suspension under analysis and suspends, for the current FY, the annual depreciation of the cost of fixed assets, must allocate – when approving the financial statements relevant to the FY being current at 15 August 2020 – profits corresponding to the suspended depreciation charge to a restricted reserve. If FY profits are lower than the depreciation charge, such reserve is integrated with available reserves. If there are no reserves, the restricted reserve is integrated by allocating profits of following FYs.

This reserve is classified as restricted reserve that cannot be distributed to shareholders nor allocated as capital; it can be used however to cover losses.

The regulation does not indicate how to release the restricted reserve. It is therefore assumed that, if the depreciation period is extended by one year, the reserve will be available at the end of the depreciation period. On the other hand, if the depreciation period remains unchanged (and the suspended depreciation charge is distributed among the residual useful life), it will be gradually released in the FYs, depending on the higher depreciation charge attributed. It can also be assumed that the reserve can be released in case of sale or write-down of the concerned fixed asset.

5. Explanatory notes

As mentioned above, the Explanatory Notes relevant to the FY being current at 15 August 2020 must include an explanation of the reasons underlying the choice to apply the suspension of depreciations and indicate the concerned assets and the amount of suspended depreciations, as well as the economic and financial impact of the suspension.

Assonime comments that the explanatory notes should specify that the suspension was applied and include a brief explanation of the reasons underlying this choice. Apparently, an analytical explanation of such reasons is not necessary.

As concerns the economic and financial impact of the suspension, an explanation of the different amount in the balance sheet and in the income statement should be provided, if the depreciation suspension is not applied.

6. Tax regulation

Art. 60, para. 7-quinquies of Law Decree n.104 of 2020 states that the depreciation rates suspended for accounting purposes can be deducted for tax purposes, within the limits provided by the IRES and IRAP regulation, regardless of their imputation in the income statement.

According to Assonime, this is not an optional regime from a tax perspective. While the possibility to choose whether to apply the suspension of depreciation or not is granted for accounting purposes, the same is not valid from a tax perspective.

The Revenue Office expressed its point of view during Telefisco 2021 event. On this occasion, it was asked whether the deduction of suspended depreciations was mandatory or optional and the Revenue Office answered that the regulation connects from a tax perspective the suspension option granted at accounting level, providing that the non-imputation of the depreciation charge in 2020 income statement does not impact on its tax deductibility, which is in any case confirmed.

Therefore, the mandatory tax deduction of depreciation charges relevant to 2020 creates a misalignment between the accounting and the tax value of assets, thus requiring the allocation of deferred tax liabilities, i.e. of taxes corresponding to the suspended accounting depreciation charge that will have to be taxed in the future, when it will be entered in the income statement.

Given the above, the benefit deriving from the suspension of depreciation charges on the 2020 financial statements will be equal to the amount of suspended charges net of deferred tax liabilities allocated in the financial statements.  

Moreover, this approach could also impact the amount of the restricted reserve to be allocated due to the suspension of depreciations. Although art. 60, para. 7 ter, provides that the amount of this reserve must correspond to the amount of the suspended depreciation charge, it is clear that profits to be allocated to this reserve must be compared, rather than to the gross amount of suspended depreciations, to the amount of depreciation net of the corresponding deferred tax liabilities.