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Article:

Tax accounting for lessees under IFRS 16

15 February 2018

In December 2017, HMRC published two consultations on the way forward for the post-IFRS 16 tax environment for lessees. One focusses on the Interaction with the corporate interest restriction regime for leases and the other on potential plant and machinery lease accounting changes. It is proposed that any new legislation will take effect for accounting periods commencing on or after 1 January 2019.

 

Outline

An earlier consultation exercise in 2016 concluded that the current tax approach for leases should be broadly preserved, rather than moving to a system of accounts-based depreciation.

The key new proposal is that the Government intends to abolish the 'frozen GAAP' provision in section 53 Finance Act 2011. Tax rules will then be able to take into account changes in lease accounting standards. That should mean there is no requirement for all lessees to maintain two sets of books - one for accounts, another for tax. Of course, tax adjustments to accounts figures will continue to be necessary when preparing lessee tax computations eg, rental restrictions for long funding leases.

 

The transition

Any transitional accounting adjustments on adopting IFRS 16 should be tax effective in the year of change, and the law will be amended to ensure that this is equally the case for early adopters. In practice, there may be limited transitional adjustments given it is proposed that operating lessees adopting IFRS 16 must recognise the asset for tax purposes at a value equal to the lease liability (regardless of whether that is the chosen accounting option).

For long funding leases, there may, however, be a transitional rebasing of the amount of capital allowances available to an operating lessee - reflecting the absence of grandfathering treatment for existing leases. In some cases, this may give rise to a tax timing disadvantage as the disposal value (based on the residual value at date of transition) may exceed the new qualifying expenditure (based on the PV of the remaining lease payments).

 

Longer ‘short’ leases

One other important proposal is that the Government plans to extend the definition of a short lease to include any new lease with a term no greater than seven years (eg, removing the conditionality around five to seven-year term leases). The impact of this is that such a lease falls outside the 'long funding lease' rules and so capital allowances remain with the lessor.

The new rules are likely to have the most impact on operating lessees who adopt IFRS 16. For example, most property leases will move from straight line rental deductions to a finance deduction (upfront weighting) and straight line depreciation deduction. In practice, non-depreciated assets may be limited to a finance deduction. By contrast, the new rules should have little impact on companies who continue to apply UK GAAP rather than IFRS.

 

Interaction with the corporate interest restriction regime

This consultation is being undertaken to decide how best to achieve the BEPS 4 objective of treating finance lease finance costs as interest (and thus capable of restriction). One proposal suggests that bringing leased assets onto the lessee's balance sheet under IFRS 16 may give rise to interest for the first time. Whereas another proposal would enable an IFRS 16 lessee to escape interest treatment if the lease were an operating lease for the lessor.

There will be further technical changes to tax legislation to replace the finance lease test with one which doesn't rely upon an accounting definition and, therefore, cannot be manipulated by choice of accounting framework (eg, UK GAAP or IFRS).

Read Corporate interest restriction – consultation on leases and Plant and machinery lease accounting changes. Both consultations are open for comment until 28 February 2018.

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