Losses on Long-term Construction Contract

Accounting Treatment:
35. When it is probable that total contract costs will exceed total contract revenue, the expected
loss should be recognised as an expense immediately.
36. The amount of such a loss is determined irrespective of:
a. whether or not work has commenced on the contract;
b. the stage of completion of contract activity; or
c. the amount of profits expected to arise on other contracts which are not treated as a
single construction contract in accordance with paragraph 8.
36. When it is probable that total contract costs will exceed total contract revenue, the
expected loss shall be recognised as an expense immediately.
37. The amount of such a loss is determined irrespective of:
(a) whether work has commenced on the contract;
(b) the stage of completion of contract activity; or
(c) the amount of profits expected to arise on other contracts which are not treated as a
single construction contract in accordance with paragraph 9.
Tax treatment:
Old Practice:
6. Paragraphs 21, 31 and 35 of SSAP 23 provide that any expected excess
of total contract costs over total contract revenue for the contract should be
recognised as an expense immediately. In other words, a loss on a contract as a
whole recognised in the accounts as soon as it is foreseen. However, it is the
Department’s view that an expected loss recognised in accordance with paragraph
35 of SSAP 23 can only be accepted as having been incurred for taxation purposes
to the extent that the amount is determined in accordance with paragraph 7 below.
7. It is considered that a proportion of the overall loss referred to in
paragraph 6 above, calculated either by reference to time (normally up to the due
completion date under the terms of the contract), or to expenditure incurred, may
be taken into account year by year during the remainder of the contract period.
This is so as long as all contracts, profitable or otherwise, are dealt with similarly.
New Practice:
DIPN 1 – Treatment for losses on long-term construction contracts under paragraphs 6 and 7 of Part B of DIPN 1 – Provisions for foreseen losses on long-term contracts
The position of the Inland Revenue Department (“IRD”) is as set out below.
The Hong Kong Court of Final Appeal’s decision in CIR v Secan Ltd. and Ranon Ltd. ((2000) 5 HKTC 266) (“Secan”) establishes the principle that the tax treatment should follow the accounting treatment. The IRD’s view is that the principle should generally apply to all types of income and expense, except as otherwise provided for by the Inland Revenue Ordinance ("IRO"). As the making of provisions for foreseen losses is required by generally accepted accounting principles, and is not inconsistent with the provisions of the IRO, the IRD has confirmed that paragraphs 6 and 7 in Part B of DIPN 1, which was issued before Secan, are no longer applicable. Following Secan, the IRD agrees to allow a full deduction in the year the provisions are recognised in the accounts, provided that they are (i) made in accordance with the established accounting practice; and (ii) estimated with sufficient accuracy.
The new practice will apply to any open years of assessment (current or back years) including those under objection.
The IRD will revise DIPN 1 in due course to reflect the above position.
 
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