Under Hong Kong Accounting Standard 17 ("HKAS 17"), if a lessee of premises is required under the terms of a lease agreement to reinstate the condition of the premises back to their original condition at the end of the lease, the lessee should accrue the reinstatement cost as an additional cost of the initial renovation based on the best estimate of the eventual costs of restoring the premises to their original state. Under such circumstances, could the estimated reinstatement cost be treated as part of the capital expenditure incurred on the initial renovation and qualify for commercial building allowance?
No, the estimated reinstatement cost does not qualify for commercial building allowance. According to HKAS 17, the lessee is required to recognize the estimated cost of reinstating the premises to their original condition as a provision. Since the estimated cost of reinstatement is a provision and no actual expenditure has been incurred, the estimate or provision does not qualify for commercial building allowance.
If the lessee has actually incurred expenditure to reinstate the premises to their original condition before the end of the lease term (i.e. within the lease term), would the actual reinstatement cost incurred qualify for commercial building allowance?
No, the actual reinstatement cost incurred does not qualify for commercial building allowance. The actual expenditure so incurred is for the purpose of restoring the alterations made to the premises when the lease comes to an end. It is not incurred on the construction of a commercial building or structure or incurred to acquire a relevant interest in that building or structure. Further, the premises are to be surrendered to the lessor after reinstatement. The expenditure therefore fails to satisfy the test under section 18F of the Inland Revenue Ordinance ("IRO") which provides for the allowances under Part VI to be deducted from assessable profits to the extent to which the relevant assets are used in the production of such profits. As the reinstated premises are no longer occupied by the lessee in the production of assessable profits, the actual reinstatement cost does not qualify for commercial building allowance.
Is the actual amount of reinstatement cost allowable for deduction under section 16 of the IRO?
No, the actual amount of reinstatement cost is not deductible under section 16 of IRO. Where the lease is a capital asset, the reinstatement cost when incurred is regarded as part of the capital cost of acquiring the lease. The expenditure is therefore capital instead of revenue in nature. Thus, it is precluded from deduction under section 17(1)(c) of the IRO.