Accounting Considerations for Independent Power Producers and their Investors
The South African energy industry is being transformed by the Department of Energy’s (DoE) Independent Power Producer Procurement Programme (IPP Programme). Many power purchase agreements (PPAs) have been signed between Eskom and Independent power producers (IPPs) and many more are expected to be. The energy generated by the IPPs supplements the energy generated by Eskom. The IPP Programme participants face unique accounting challenges. This publication highlights some of the major accounting considerations for IPPs and their investors.
Costs incurred prior to securing a power purchase agreement (PPA)
Potential IPPs incur significant upfront costs in relation to company structures and incorporation, administration, professional advice and feasibility studies. They may also be charged management fees by investors or other sponsors.
- The main consideration is whether these costs should be capitalised or expensed. In general, these costs should be expensed as incurred. However, depending on how the transaction is structured, there are cases where such costs may be capitalised by the IPP when on-charged by another entity that incurred the costs.
- IPPs should also consider whether a deferred tax asset can be recognised in respect of “pre-trade date” expenditure and if so, when it can be recognised.
- Some of the costs incurred prior to securing a PPA may qualify for deduction when the IPP is seen to commence trade per the Income Tax Act of South Africa. Only those costs that would have been deductible if they were incurred whilst carrying on a trade can be carried forward and deducted in full once trade commences. For example, costs in relation to salaries, security, bank charges, audit fees, tax compliance fees and stationery can be carried forward and deducted for tax once trade commences as they are not of a capital nature. However, professional fees in relation to developing the project that are capital in nature cannot be carried forward.
A deferred tax asset can only be recognised to the extent that it is probable that taxable profit will be available, against which the pre-trade expenditure can be deducted. As such, it is also important to determine if and when the probability criterion can reasonably be demonstrated.
IPPs may be obliged to pay a success fee to investors, other sponsors or professional advisors on “financial close”.
- The main consideration is whether these costs should be capitalised or expensed. There are instances where these costs may be capitalised.
- The South African Revenue Service (SARS) does not currently provide any deductions or allowances for success fees paid/payable in relation to developing the project as they are considered to be capital in nature. This will lead to a “permanent difference” between the accounting and tax treatment.
PPA and related agreements
IPPs need to consider the nature of the agreements that they enter into. In our experience, the applicability of IFRIC 122 , IFRIC 43 , and IFRIC 184 should be assessed. Application of IFRIC 12 or IFRIC 4 could result in the energy-related infrastructure not being recognised on the IPP’s statement of financial position (SFP). If IFRIC 18 is applicable, the IPP would need to assess whether assets transferred to it by its customer meets the definition of an asset in the IPP’s financial statements.
Share-based payment transactions
IPPs often exchange their shares for services or for Black Economic Empowerment (BEE) credentials (e.g. they may issue shares to black individuals/entities or to a trust with black beneficiaries). » Important accounting considerations include whether share-based payment accounting is applicable and whether an expense is recognised. Where shares are issued in exchange for goods or services, including BEE credentials, this generally results in the recognition of an expense. » Deferred tax will arise if the IPP receives a tax deduction that differs in amount and timing from the share-based payment expense recognised. However, in our experience, if IPPs issue shares in exchange for development services, then no tax deduction would be available from SARS. This is firstly because it is unlikely that an issue of shares would be regarded as an “expense” for the IPP (it doesn’t make the IPP any poorer), and secondly because it is likely to be an expense of a capital nature. If no tax deduction is granted, no deferred tax arises.
Loans from investors
If loans are received at below-market interest rates, the difference between the transaction price and the initial fair value generally represents an additional equity contribution from the investor (this is because all financial instruments are required to be initially measured at fair value). In addition, the effective interest to be recognised in profit or loss may not be the same as contractual interest payable.