Consultation on the tax aspects of accounting changes for leases

Mon 18 Dec 2017

On 1 December HMRC released two consultations concerning the tax implications for leasing of adopting IFRS16:

• A consultation on maintaining as far as possible the existing tax treatment for plant or machinery leases when IFRS16 is adopted in 2019, with tax changes taking effect from 1 January 2019.
• A consultation on amending the corporate interest restriction rules to accommodate changes to the lease accounting rules to be included in IFRS 16, with the tax changes taking effect from 1 January 2019.

Accounting changes

IFRS16 will be mandatory for annual accounting periods commencing on or after 1 January 2019, though early adoption is permitted. For lessees using IFRS 16, leases would no longer be classified as either finance leases or operating leases, though there would still be that distinction for lessors. It is expected that FRS102 and FRS105 will continue to apply IAS17 (which requires identification of finance and operating leases for both lessees and lessors), but will in due course be updated to align with IFRS 16.

Lessees using IFRS16 will have to account for all leases ‘on balance sheet’. This will involve recognising an asset and liability, amortising or depreciating the asset, and treating lease payments as partly for principal and partly for a finance charge. The finance charge is the amount representing a constant periodic rate of interest on the remaining lease liability.

Amongst other things, this change will impact all businesses using IFRS who are tenants under leases, though there is an option to continue to use accounting similar to IAS17’s operating lease accounting for ‘short term’ leases (leases with a term of less than 12m and no purchase option).

Proposals for changes to the tax treatment of plant or machinery leases

Following an August 2016 consultation the Government has decided to follow the majority view of maintaining the status quo for tax, which will mean:

• For lessors using either IFRS 16 or FRS 102 and for lessees using FRS 102 (both of which groups will continue to distinguish between operating and finance leases), the existing rules in principle will be used in determining the tax treatment for leases.
• For lessees using IFRS 16, the long funding lease rules (as amended) will need to be considered.  Where a finance or operating lease is a long funding lease the capital allowance rules will apply and there will also be a deduction for a finance cost.
• Where the long funding lease rules do not apply, the application of generally accepted accounting practice – whether IFRS 16 or FRS 102 – will, subject to existing exceptions, continue to give the quantum of the rental payments that are allowable revenue deductions for tax purposes.

This may affect the timing of tax deductions for certain operating leases where IFRS16 is adopted. For example, the accounting for a finance charge on a property lease may mean higher deductions (together with the depreciation charge) earlier in the lease compared to a straight line apportionment of costs over the lease term (or to the rent review date).

Amongst a number of other implications discussed, it is worth noting that FA 2011 s.53, which has temporarily overridden accounting changes for leases, will be removed.

Proposals for accommodating the lease accounting changes in the corporate interest restriction rules

Three options are proposed for amending the CIR rules to deal with these accounting changes. They would apply whether or not the taxpayer used IFRS 16.  The options are:

• Follow the accounting (this could increase interest restrictions for some groups);
• Keep the distinction between operating and finance leases for CIR purposes (this would have a similar effect to the current rules);
• Introduce a distinction between ‘funding’ and ‘non-funding leases’ (this would have a similar effect to the current rules).

Action

Businesses should be reviewing the potential impact of the proposed tax changes. To discuss the tax issues of leasing arrangements and the interaction with capital allowances or corporation interest restrictions, please get in touch with a member of the Mazars Corporate Tax or International Tax teams.