Commissioning is the systematic quality assurance process of proactively verifying facility equipment and systems meet owner requirements, Building Code mandates, and certification prerequisites. This process is performed through review, documentation, feedback and acceptance at all phases of a project. Commissioning requires an upfront investment but included in the many benefits to property owners is the ability to use commissioning to optimize their tax liability.
GMC Cx creates value for owners by partnering with them to efficiently execute a commissioning process resulting in significant savings for the owner in both initial construction costs, facility operating costs and reduced tax liability. The difference between an owner’s investment in securing GMC Cx services and what they will pay for a non-commissioned project is their return on invested capital (ROIC), or as we call it, return on invested commissioning (ROICx).
Optimize Your Tax Depreciation with Commissioning
Not to be confused with personal protective equipment; property, plant and equipment (PPE) is a line item on many companies’ Balance Sheets. In compliance with the International Accounting Standards (IAS) 16, PPE is a classification of a company's fixed assets or capital assets, such as buildings, computers, furniture, land, equipment and machinery that are expected to be used for more than a year. PPE is shown on the balance sheet grouped together at original cost (initial recognition), minus net accumulated depreciation.
For an asset to be classified as a fixed asset, it must be fundamental to the company’s operations - that is, it must be an operating asset. It also must exceed the businesses capitalization limit.
Initial Recognition - Bringing the Asset to Working Condition for Its Intended Use
At initial recognition, an entity measures a fixed asset at its fair value plus transaction costs that are directly attributable to the acquisition. As per IAS 16, the fixed asset should be initially recognized at cost including all costs necessary to bring the assets to working condition for its intended use1.
This includes not only its original purchase price, but also costs of site preparation, delivery and handling, installation, related professional fees for consultants and commissioning cost minus cost to be incurred on dismantling the asset upon its decommissioning.
Here is a full list of potential costs for a fixed asset which could be capitalized:
· Legal costs specific to the purchase and construction of the specific asset
· Initial delivery and handling costs
· Import duties
· Installation costs
· Purchase transaction costs
· Property transfer taxes
· Architect and engineering costs specific to the asset
· Site clearance costs
· Construction labor and materials
· Interest during construction
· Start-up costs
· Commissioning and functional testing
Commissioning is proof that assets are in service. The IRS has taken positions in several revenue rulings consistent with the idea that full operational use of an asset is a prerequisite for it to be considered as placed in service. Rev. Rul. 79-98, for example, states that a nuclear electric generating facility was placed in service when “the unit was able to operate at its rated capacity without failure.”2
Deduction of Repair and Maintenance Costs
Well commissioned equipment that has been right sized, installed correctly, tested to minimize short cycling, and correctly maintained by trained operators should last through its useful life.
The IRS allows you to deduct all the ordinary and necessary expenses you incur during the taxable year including the costs of supplies, repairs, and maintenance.
Routine maintenance which keeps your property in proper working condition is a simple current year deduction. However, repairs that occur after the warranty period has expired run the risk of being classified as a Capital Improvement if replacing more than 30% of the equipment. This is one reason why $1 spent on quality commissioning and correct maintenance is worth $10 in repairs.
Per IRS Publication 535 you can elect to capitalize and depreciate certain amounts paid for repair and maintenance of tangible property, even if they do not improve your property3. To qualify for this election, you must treat these amounts as capital expenditures on your books and records used in figuring your income. If you make this election, you must apply it to all repair and maintenance costs of tangible property that you treat as capital expenditures on your books and records for this tax year.
Re-Commissioning or Continuous Commissioning
Commissioning is an investment, given its long-term benefit in terms of building performance. Re-Commissioning (commissioning in an existing building) or continuous commissioning occurs post occupancy and operation of a project and consists mostly on inspection, analysis and control adjustments with no major capital expenses. This is considered “maintenance” and can be deducted in the year it occurs.
Avoiding Early Equipment Failures
Quality commissioned and maintained equipment will still have value after it has been fully depreciated. It can be re-sold at a higher price or can continue to operate, saving the capital cost of replacement. However, all assets except land eventually wear out. When disposing of a plant asset, a company must remove both the asset’s cost and accumulated depreciation from the accounts which means writing off the asset’s cost and the accumulated depreciation.
Non-commissioned and abused equipment may fail before it has been fully depreciated. This discrepancy may cause problems with getting cash from your insurance company to purchase comparable equipment in a loss because the tax record and depreciation is the only proof of value you have.
Working Example4
For example, your company purchased 10 Rooftop Units (RTUs), each for $15,000 (inclusive of cost, insurance during transit and freight). $50,000 was paid to architects and engineers for the design and $100,000 was paid to contractors to install the RTUs. You financed the equipment with a loan at 10% per annum inclusive of insurance charge of 2% over the useful life of the RTUs, which is 15 years. The RTUs must be commissioned and functionally tested per Code before putting them in operation. The cost for commissioning the RTUs, including design, submittal, construction reviews and functional testing amounts to $3,000 per RTU.
The total cost at which the 10 RTUs should be capitalized works out to $330,000. The interest expense and insurance over the life of the RTUs are excluded because these expenses are not required for putting the asset to its intended use.
After the RTUs run out of their useful lives, this fixed asset has a residual value or salvage value. Fixed assets are depreciated only to the extent of their depreciable amount, which equals cost minus the salvage value.
Depreciable Amount = Cost - Salvage Value
The RTUs in the example about have a useful life of 15 years each and their residual value at the end of 15th year will be 10% of the customs value or the Cost, Insurance and Freight (CIF) value i.e., $15,000. The depreciable amount is therefore $315,000 ($330,000 - $15,000).
Under the straight-line depreciation method, the depreciation expense for each year will be ($315,000)/15 = $21,000 per year. Assuming a tax rate of 28%, this depreciation reduces your companies tax liability by $5,888. The total commissioning cost was $30,000; however, had this not been included in the initial recognition the depreciation expense for each year would be $300,000 instead of $330,000. While this does not seem significant, the additional depreciation for commissioning saves your company $8,400 in tax liability over 15 years.
During operation, proper, preventive maintenance of the 10 RTUs costs $7,500 annually. However, on year 4, one of the RTUs fails early. A compressor and motor replacement costs $5,000, which is more than 30% the depreciated value of the equipment. This cost must be capitalized and depreciated over the remaining life of the unit instead of in the year of repair. While there is some tax break, it is not as significant because of the spread-out nature of depreciation and the time value of money.
Because of this early failure, the owner decides to perform re-commissioning of the system. During re-commissioning, the commissioning agent finds that the office space the unknit was serving was empty, but the unit remained on. The constant short cycling contributed to the early failure. It was also found that 2 other units were serving spaces that had changed use. Based on this information, the owner decided to make controls changes to reflect current operations. Not only did this effort save other RTUs from early failure and possible write off, but this work by the CxA is tax deductible to the owner.
Owners who make the investment in commissioning reap significant benefits above and beyond energy and tax savings. They discover problems early, assure project accountability, and have documented confirmation that building systems and equipment meet the design intent and they gain the full lifecycle value out of their capital investment in building equipment and systems.5
Consider this scenario multiplied by the number of facilities that a company owns. The reduced tax liability and added value of building system optimization results in a significant positive affect to the company’s bottom-line.
About GMC Commissioning
GMC Commissioning was founded in 2017 based on fundamental principles and a grand vision. Our mission, since day one, is to advance the industry towards optimal performance and quality. We provide the highest level of service through expertise and Elevate Project Delivery by challenging the status quo. We ensure our clients get what they expect so their business can focus on what they do best.
GMC Commissioning (GMC Cx) is an independent, full-service commissioning provider & owner's agent for new & existing facilities. Headquartered in San Diego, CA with an Atlanta, GA office; GMC Cx works with national and international clients around the globe. A registered California Corporation and Small Business Enterprise (SBE); GMC Cx is a true owner-operated, third-party commissioning firm with no affiliations or associations.
References:
1. “IAS 16 — Property, Plant and Equipment.” Iasplus.com, 2011, www.iasplus.com/en/standards/ias/ias16. Accessed 22 Mar. 2021.
2. “Placed-In-Service Decision Requires Careful Planning.” The Tax Adviser, 1 Nov. 2007, www.thetaxadviser.com/issues/2007/nov/placedinservicedecisionrequirescarefulplanning.html. Accessed 22 Mar. 2021.
3. “Publication 535 (2018), Business Expenses | Internal Revenue Service.” Irs.gov, 2018, www.irs.gov/publications/p535.
4. Model used based on modified example from “Fixed Assets” article Obaidullah ACA, CFA, Jan. “Fixed Assets.” Xplaind.com, 5 Apr. 2019, xplaind.com/613280/fixed-assets. Accessed 22 Mar. 2021.
5. J. Liesman, CFM, Paul. “Commissioning: Making It Pay.” Facilitiesnet, 1 Nov. 2005, www.facilitiesnet.com/energyefficiency/article/Commissioning-Making-it-Pay--3515. Accessed 22 Mar. 2021.