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, IPPs and many more are expected to be. The energy generated by the IPPs supplements the energy generated by Eskom.
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 investor or other sponsors.
The main consideration is where 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.
Further, IPPs may be obliged to pay a success fee to investors, other sponsors or professional advisors on “financial close”. However, the South African Revenue Service (SARS) does not currently provide any deductions or allowances for success fess 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.
When it comes to loans, should it happen that they 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. In addition, the effective interest to be recognised in the profit or loss may not be the same as contractual interest payable.
There are also decommissioning and environmental provisions to be considered. Legal, contractual or constructive obligations to restore sites or dismantle assets in the future may need to be accounted for as a provision on construction of the assets, to the extent that damage has been caused by construction. In this case, deferred tax will generally arise on the decommissioning provision and asset as deductions for some/all of the expenditure is only allowed in future years when the expenditure is actually incurred.
Perhaps the pertinent challenge is revenue recognition. There are practical challenges in determining how IPPs should account for early operating and deemed revenue. This includes the timing and amount of revenue to be recognised. Therefore, IPPs may face estimation uncertainty when applying the principles of revenue recognition, for example where meter readings don’t coincide with reporting periods.
Ultimately, it is important that the specific transactions and contracts be carefully evaluated to assess the appropriate accounting treatment.
Tara Smith is the director of reporting accounting and assurance solutions at KPMG Advisory
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