The Initial Cost of a Construction in Tax Accounting: Fiscal Uncertainty and a Mechanism for its Elimination.

Zharkov Ruslan Aleksandrovich ORCID: 0000-0001-8730-993X Student, Department of Taxes, Audit and Business Analysis, Financial University under the Government of the Russian Federation 127083, Russia, Moscow, 8 Marta str., 2/10 rouslan.079@gmail.com

Introduction The construction industry is one of the key sectors of the Russian economy, the functional role of which is to create new ones, as well as reconstruction, expansion, repair and technical re–equipment of existing fixed assets for industrial and non-industrial purposes.

Construction is one of the most complex industries from the point of view of both accounting and tax accounting, which is due to the specifics of the industry: territorial isolation of construction objects, specific documentation, individual nature and duration of construction production, variety of types of construction and installation work, versatility of participants in the construction process, multi-stage system of settlements between participants, etc ^[1]. According to the results of a survey of business activity of more than 6 thousand construction organizations conducted by Rosstat on 10.03.2022, it was revealed that a third of respondents attributed the high tax burden to a number of main factors constraining the activities of organizations in the construction industry.

 Taking into account the above, the problem of uncertainty of some aspects of tax legislation comes to the fore for construction companies.

The purpose of the study is the analysis of fiscal uncertainty regarding the formation of the initial cost of a construction object and the search for a mechanism to eliminate it.

Achieving this goal required solving the following tasks:

1) analysis of the current rules and approaches to determining the initial cost of a construction object in tax accounting;

2) identification of tax risks of uncertainty of inclusion of costs in the initial cost of a construction object for construction companies;

3) development of a methodological approach to determining the initial cost of the construction object.

Current rules and approaches to determining the initial cost of a construction object in tax accountingThe initial cost of an object of fixed assets is its actual cost at the time of reflection in the accounting of the organization, that is, the cost estimate in which the object is accepted for accounting / tax accounting.

The determination of this value is necessary, first of all, for the calculation of depreciation charges – the amount written off monthly to income tax expenses depends on the initial cost. In addition, the initial cost is the basic value for determining other types of the value of fixed assets: residual/balance sheet, replacement. As a general rule, the initial cost of an object is a set of costs associated with its acquisition, creation/manufacture and preparation for operation. The procedure for determining the initial cost depends on the method of receipt of the object in the organization. For example, the initial cost of a fixed asset purchased for a fee will be formed by the amounts paid in accordance with the contract to the supplier (seller), as well as the amount of costs associated with bringing the object to a condition suitable for use ^[2,3]. Types of the initial cost of an object of fixed assets are shown in Figure1.

Figure 1. Types of the initial cost of an object of fixed assets ^{[4, 5]}

For accounting purposes, capital investments include the costs of the organization for the acquisition, construction, construction, manufacture of the object, preparation of project documentation, organization of the construction site, delivery and preparation of the object for operation, etc. A detailed list of actual costs, taken into account and not taken into account when recognizing capital investments, is specified in section II of FSB 26/2020 "Capital investments" ^[6,7].

Unlike accounting rules, Russian tax legislation does not currently contain a detailed list of costs that can be included in the initial cost of an object of fixed assets and, in particular, a construction object ^[8]. In paragraph 1 of Article 257 of the Tax Code of the Russian Federation, there is a general formulation for the formation of the initial cost of fixed assets. For a long time, the application of this rule has been accompanied by constant disputes: specific types and elements of costs are usually disclosed in often contradictory explanations of the Ministry of Finance and the Federal Tax Service of Russia, however, this list is not exhaustive.In order to minimize the uncertainty of including costs in the initial cost of a construction object, as well as in an effort to find out whether there is a relationship between the types of construction costs included in the initial cost and the construction object, the elements of construction costs in the article were systematized into a table by summarizing the accumulated experience (see Table 1).

Table 1 – Types of costs forming the initial cost of the construction object [compiled by the author based on the analysis of materials of judicial practice]

Thus, during the analysis of the practice of government explanations on the issue under consideration, it was not possible to identify a direct relationship between the types of construction costs that form the initial cost and the construction object, whether it is a residential building, industrial or public building, road complex, etc. This means that if there are costs specific to a particular type of construction that can be included in the initial cost of the object (for example, the costs of the developer of residential real estate in connection with the provision of monetary compensation to immigrants), there were no differences in the approach to including certain costs in the initial cost based on the difference in construction objects. 

Despite the fact that the absence of a unified approach to the list of types of costs included in the initial cost of a construction project in tax accounting leads to uncertainty and risks for any company engaged in construction, the degree of uncertainty is significantly less with respect to some costs. Thus, the legality of including in the initial cost of the object under construction the expenses of the organization for the purchase of raw materials, tools, equipment, fixtures, etc., necessary for construction; amounts paid to the counterparty under construction contracts and other contracts; labor costs of personnel directly working on the construction site, lease payments and depreciation of construction equipment and similar expenses, directly follows from the wording specified in paragraph 1 of Article 257 of the Tax Code of the Russian Federation. Such costs can be attributed to the direct costs of the construction organization for the performance of construction and installation works (directly at the facilities) ^[9]. They are easily classified as expenses related to the construction of a construction object and, as a rule, do not raise questions in practice. At the same time, specific types of costs, for example, expenses for the development of natural resources directly related to the construction of facilities that may later become permanently operated fixed assets, are included in the initial cost of the object, without causing uncertainty, due to the direct indication of the approach to such costs in a separate norm (clause 4 of Article 325 of the Tax Code of the Russian Federation).

Along with this, the cost of buying land for construction does not objectively form the initial cost of the construction object. Due to the fact that, by virtue of paragraph 2 of Article 256 of the Tax Code of the Russian Federation, environmental management objects, including land plots, are not subject to depreciation, the costs associated with the acquisition of land form the initial cost of the plot itself and are not taken into account for profit taxation purposes, even if the sole purpose of buying the plot is construction. A similar procedure applies to the company's expenses for external landscaping (construction of paths and lawns, planting trees, etc.) during construction, which, in accordance with paragraph 4, paragraph 2 of Article 256 of the Tax Code of the Russian Federation, are not amortized. The expenses of the construction company for the payment of land tax also do not form the initial cost of the object, but relate to other expenses (Clause 1, clause 1, Article 264 of the Tax Code of the Russian Federation). Obviously, the land tax is not directly related to the construction process and is paid independently of it. The firm charges land tax due to the fact that it is the owner of a land plot as a separate object of taxation, and therefore the costs of paying it are not included in the cost of the object under construction.

Uncertainty in the formation of the initial cost of a construction object, as well as the greatest risk for construction companies, arises in a situation where costs with equal right can be taken into account for profit taxation purposes both as current costs and in the form of depreciation charges, and at the same time the direct connection of costs with the construction of the object is clearly not traced.  In addition, the issue of including such expenses in the initial cost is often burdened with contradictory explanations of the authorities and controversial judicial practice, which causes difficulties for taxpayers. 

So, let's consider the costs of a construction organization for the liquidation (demolition, dismantling) of an object of fixed assets in order to carry out the construction of a new facility. In accordance with the Tax Code of the Russian Federation, when an object of fixed assets is liquidated, the costs of such liquidation, including non-accrued (linear method) depreciation, relate to current expenses, in particular to non-operating expenses (Clause 8, clause 1, Article 265 of the Tax Code of the Russian Federation). Nevertheless, the Ministry of Finance of the Russian Federation in its explanations, referring to paragraph 1 of Article 257 of the Tax Code of the Russian Federation, has repeatedly noted that the costs of liquidation (dismantling, demolition) of a capital construction facility incurred in preparation for the construction of a new facility, as well as the residual value of the objects being liquidated and even the costs of their acquisition, are associated with the construction of the object being created and, therefore, form its initial cost ^{[10, 11, 12]}. This position is supported by some courts, which, rejecting the party's reference to Clause 8, clause 1, Article 265 of the Tax Code of the Russian Federation, classify the costs of liquidation of the facility as preparatory work related to the construction of the construction facility ^[13]. Based on the explanations of the Ministry of Finance of the Russian Federation, it can be concluded that all expenses related to the object being liquidated (dismantled, demolished), including its residual value, are included in the initial cost of a new fixed asset ^[14]. The previously mentioned letter of the department is also important because in it the Ministry of Finance of the Russian Federation formalizes a principled position – all costs associated with the creation of an object form its initial cost, regardless of the indication of such costs in Articles 264 and 265 of the Tax Code of the Russian Federation.

However, it should be noted that earlier the Ministry of Finance of the Russian Federation directly pointed out that the costs of liquidation (demolition, dismantling) of fixed assets (including the amount of non-accrued depreciation) do not form the initial cost of construction of new facilities and are taken into account for profit taxation purposes in non-operating expenses ^[15]. At the same time, the opposite position was reflected in an even earlier period, in the explanations of the Ministry of Internal Affairs of the Russian Federation: letter dated 23.08.2004 N 26-12/55121 indicates the possibility of taking into account in the initial cost of a new object the costs of preparing a construction site in terms of the costs of demolition of buildings located on it ^[16].

In accordance with the Tax Code of the Russian Federation, interest on debt obligations of any kind is reflected as part of non-operating expenses. The explanations of the Ministry of Finance of the Russian Federation have also repeatedly pointed out that such expenses are not included in the initial cost of the object under construction ^[17]. It is important to emphasize that the Ministry of Finance of the Russian Federation justifies its position solely by the presence in the Tax Code of the Russian Federation of a special procedure for accounting for interest on loans and borrowings (paragraph 2, paragraph 1, Article 264 of the Tax Code of the Russian Federation). That is, in the absence of a special order, obeying the logic of clause 1 of Article 257 of the Tax Code of the Russian Federation, interest expenses should form the initial cost of the construction object. Nevertheless, in accordance with the previously mentioned position of the Ministry of Finance of the Russian Federation, all costs associated with the creation of an object form its initial cost, even if they are specified in Articles 265 and 264 of the Tax Code of the Russian Federation. Moreover, earlier the Ministry of Finance of the Russian Federation considered that interest on a loan aimed at the construction of depreciable property, paid during the creation of the fixed asset, is taken into account as part of its original cost ^[18].

Polar uncertainty arises when an organization incurs expenses in the form of lease payments. In this case, the Ministry of Finance of the Russian Federation does not take into account the existence of a special accounting procedure for such costs (Clause 10, clause 1, Article 264 of the Tax Code of the Russian Federation) and, guided only by clause 1, Article 257 of the Tax Code of the Russian Federation, classifies the rent for the land plot (before and during construction) as forming the initial cost of the object under construction ^[19]. The agency also ignores the special norm with respect to expenses related to the liquidation of the facility for new construction (Clause 8, clause 1, Article 265 of the Tax Code of the Russian Federation). At the same time, there are judicial acts according to which it is necessary to take into account lease payments for the land plot on which construction is being carried out at a time. Thus, the court rejected the arguments of the tax authority that lease payments for land plots on which residential buildings are being built are subject to inclusion in the initial cost of the real estate object, referring to Clause 10, clause 1, Article 264 of the Tax Code of the Russian Federation – a special norm for accounting for lease payments ^[20].

Uncertainty also arises as to which norms of Chapter 25 of the Tax Code of the Russian Federation apply to accounting for depreciation premiums on fixed assets involved in the creation of construction projects. Expenses in the form of accrued depreciation amounts for the construction period are included in the initial cost of the object under construction ^[21]. However, when considering costs in the form of a depreciation premium, by analogy with interest, the Ministry of Finance refers to the presence of special norms in the Tax Code of the Russian Federation (paragraph 9 of Article 258 of the Tax Code, paragraph 3 of Article 272 of the Tax Code), in justification of the fact that such costs are recognized as current expenses of the organization and do not form the initial cost of the construction object ^{[21, 22]}.

Taking into account the above, it is possible that the tax authorities may require that interest on loans received and actually used to finance construction, the amount of depreciation premiums on fixed assets involved in construction and other similar expenses of the organization be attributed to an increase in the initial cost of an object under construction. On the other hand, taxpayers still have the opportunity to exploit the existing uncertainty and challenge the attribution of costs for the liquidation of fixed assets, lease payments for land and other similar costs to capital expenditures that form the initial cost of the object under construction.

Many types of costs of construction companies are not reflected at all in the explanations of the authorities. Such costs include the costs of repairing the internal communications of the building necessary for its operation (ventilation system, communication lines, fire alarm, etc.); the costs necessary for the promotion / advertising of the construction project (costs under the contract for the manufacture and placement of information on the contractor's website); the amount of depreciation of idle machinery and equipment; depreciation intangible assets; expenses related to the repair, maintenance and disassembly of temporary structures (warehouses and canopies, ladders, scaffolding, etc.); labor protection and safety expenses (expenses for the purchase of medicines, accident prevention, etc.); benefits in connection with the loss of workers' ability to work due to industrial injuries, expenses related to non-fulfillment of obligations by contractors/suppliers (additional costs for the reconstruction and alteration of facilities, search for new contractors/suppliers, etc.); expenses paid in advance under a bank guarantee or a fee for participation in a tender (before signing a construction contract); additional costs to cover the damage caused to erected/erected structures, other property damage as a result of natural disasters and other force majeure circumstances, etc.

The uncertainty of the approach to including costs in the initial cost of an object under construction poses significant tax risks for taxpayers and the state, as it leads to errors in the formation of the base for corporate income tax (in terms of depreciation), as well as for corporate property tax, if the base is the average annual value of the property. It is more profitable for a company to write off the costs of income tax expenses immediately, if there is such an opportunity, because the initial cost will have to be written off through depreciation for several years. In this case, if the tax is not paid in full as a result of the organization's underestimation of the tax base, the state will receive less tax revenue, and the organization will be fined 20% of the unpaid tax amount (Clause 1 of Article 122 of the Tax Code of the Russian Federation). That is why it is important to separate capital expenditures from current ones for the purposes of profit taxation during construction. At the same time, due to the specifics of the industry, the costs of construction projects begin even before the completion of construction and installation works (registration of permits, lease of land, purchase of building materials, etc.), and the receipt of funds is stretched over time from the initial stage of construction to the full realization of the real estate object.  This increases the relevance of resolving fiscal uncertainty regarding the types of costs that form the initial cost of a construction project for companies in the construction industry. 

Improving the methodological approach to determining the initial cost of a construction objectIn order to improve the methodological approach to determining the initial cost of a construction object, it seems appropriate to utilize the analytical tools of the Federal Tax Service of Russia, as well as the industry expertise of the Ministry of Construction of Russia and form a single digital database – an electronic service, the functionality of which will allow construction organizations to eliminate the fiscal uncertainty of including costs in the initial cost of a construction object.

To date, analytics is a priority element of the control work of the Federal Tax Service of Russia. With the help of software systems that process "big data", tax authorities manage to build a system of preventive response to possible tax risks, including in certain sectors of the economy: analysis of industry indicators when planning on-site tax audits; study, analysis and generalization of data on financial and economic activities of organizations of various industries during the work of interregional inspections for the largest taxpayers (including in the construction industry); comparison of financial, economic and other indicators of companies within the framework of the industry operating model of control, etc. ^[23].

Thus, today the tax authorities have extensive analytical expertise, including in specific sectors of the economy. It is possible to make access to the results of such analytics open to taxpayers with an appropriate need (for example, for organizations in the construction industry) within the framework of the electronic service of the Federal Tax Service of Russia. At the same time, the support of the Ministry of Construction of Russia in the development and improvement of the electronic service will be able to ensure the practical significance of analytical tools for construction companies, the accuracy and completeness of the list of typical expenses of construction organizations and methodological explanations regarding such expenses, and will also increase the effectiveness of responses to requests from organizations concerning specific costs incurred by them.

For the sake of clarity, we present a model of the structure of the new electronic service in the form of a diagram (see Figure 2).

Figure 2. Electronic service structure model for construction organizations [compiled by the author]

In order for an organization to interact with the new electronic service, it will first need to register in the "Personal Account of a taxpayer of a legal entity". If the main type of economic activity of an organization in accordance with the OKVED is "Construction", it gets access to a new electronic service. As part of the transition to a new service, the construction company will be asked to provide information about current and planned construction projects (type of object, purpose, estimated cost, construction time, etc.), with the appropriate documentation attached. Subsequently, the company will be able to aggregate expenses related to specific capital construction projects, which will allow the tax authorities to track the formation of the initial cost of construction projects in real time. This will also contribute to the transparency of the formation of the estimated cost of construction projects in the industry. Expenses during construction, recognized by the company as expenses of a current nature, the inclusion of which in the initial cost of the object is controversial, the company will also be able to reflect in the framework of the service. In case of a significant excess of the volume of current expenses over capital expenditures, the tax authorities will be able to notify the organization and warn of the potential risk of underestimation of the tax base for income tax.

The first subsection of the electronic service will contain analytical tools with which taxpayers-construction companies will be able to independently assess the level of tax risk associated with the inclusion or non-inclusion of certain types of expenses in the initial cost of the object under construction. It seems that this subsection will be publicly available to all organizations that have successfully passed registration.

Within the subsection of the organization, industry–average indicators of the structure of typical expenses of construction companies will be available, which will include both direct expenses - material costs (building materials, structures, fuel, electricity, etc.), remuneration of employees (employees directly involved in construction), maintenance and operation of construction machinery and equipment (depreciation, rent payments, repairs, maintenance, etc.), as well as indirect (overhead) costs – administrative and economic expenses, maintenance costs for construction workers, costs for organizing work on construction sites, other overhead costs ^[24].  The company will also be able to find out the average share of expenses attributed by sector organizations to current and capital expenditures. Then the service user will be able to indicate the amount of typical expenses incurred by him in the tax period, as well as reflect the attribution of such expenses to current or capital expenditures, and the service will show the deviation of the user's expenditure structure from the industry average.  It is also possible for the company to access data on the share of entities in the industry that have attributed certain expenses to current or capital expenditures. The user organization will be able to differentiate the data depending on the tax period, the type of economic activity (construction of buildings / engineering structures), the scale of activity (large, medium, small enterprise), as well as the subject of the Russian Federation.

In addition to publicly available analytical tools that allow taxpayers to independently assess their tax risks, the proposed service will include services provided on a fee-based basis. So, the second subsection of the service will be a list of methodological explanations concerning the formation of the initial cost of an object under construction in typical economic situations. This subsection may contain methodological guidelines/explanations developed by the Federal Tax Service jointly with the Ministry of Construction of the Russian Federation (the materials of the instructions may include generalization and systematization of already existing explanations of the Ministry of Finance and the Federal Tax Service of Russia), grouped by type of costs: expenses for the lease of land for construction, depreciation premium on fixed assets used in construction, liquidation of fixed assets funds for new construction, maintenance of administrative and managerial personnel and other typical expenses of construction companies. This subsection may also include explanations regarding typical cases of taxpayers underestimating the income tax base as a result of attributing a particular type of costs to current expenses instead of including them in the initial cost of an object under construction, which for the taxpayer will be an analogue of "methods of conducting financial and economic activities with high tax risk".

The third subsection of the service will allow taxpayers to prevent possible tax risks by sending separate requests to the Federal Tax Service of Russia for specific types of expenses in the absence of a standard solution in the existing digital database. The company will be asked to enter the name of the corresponding expense, mark its position on the assignment of the expense to the category of capital or current costs, and also provide a brief justification for its position. Within a certain period of time, the experts of the service, based on the analysis of the data specified by the organization in the request and during registration in the service, will provide the company with feedback approving or rejecting its position. In addition, in the format of business correspondence, the company may be asked for additional information and documents necessary for the tax authorities to make a decision (construction estimates, contracts with contractors, etc.).  It seems that by sending relevant requests by construction organizations, the Federal Tax Service of Russia will be able to expand the content base of the electronic service and form an additional subsection – "Frequently Asked Questions".

ConclusionsThus, in the course of the study, an analysis of the current rules and approaches to determining the initial cost of a construction object in tax accounting was carried out, through which it was not possible to identify a direct relationship between the types of construction costs that form the initial cost and the construction object.

The types of costs whose inclusion in the initial cost does not lead to uncertainty, costs of a contradictory nature, costs that are not reflected in the explanations of the authorities, as well as the risks associated with such uncertainty are identified. In addition, a measure was proposed to improve the methodological approach to determining the initial cost of a construction object – the electronic service of the Federal Tax Service of Russia together with the Ministry of Construction of Russia, which includes 3 subsections. The service will significantly reduce the degree of fiscal uncertainty in determining the initial cost of a construction object for construction organizations.