Lessees will recognise virtually all leases on their balance sheet under the new leases standard. This will also have tax effect accounting impacts. Here we respond to some of the more common questions we are hearing from lessees on the tax effect accounting impact of applying AASB 16 Leases.
A company entered into an operating lease of an office building prior to 1 July 2019, its date of initial application of AASB 16. On transition to the new leases standard, the lease has a remaining lease term of five years.
The company elects the modified retrospective method for transition, whereby the right-of-use (ROU) asset is measured retrospectively as if the new standard had always been applied. At 1 July 2019, the company calculated that its lease liability for the office lease is $500,000 and the carrying amount of the ROU asset is $400,000 with the difference of $100,000 recognised in retained earnings.
The tax base of the ROU asset is nil because there are no associated tax deductions from recovering the asset. The lease liability’s tax base is also nil because the lease payments are deductible in the future. This means that the net tax base of the office lease is nil. The tax rate that applies to the company is 30 percent.
Question 1: Can the company apply the AASB 112 Income taxes deferred tax initial recognition exemption* to lease liabilities and ROU assets recognised on transition to AASB 16?
Interpretive response: No. The company cannot apply the AASB 112 initial recognition exemption for deferred tax to ROU assets and lease liabilities recognised for the first time on transition to AASB 16 in respect of previously existing leases. This is because these leases existed prior to the date of initial application and have merely been remeasured on adoption of AASB 16. As a result, the company will need to consider the deferred tax consequences of recognising the office building lease on balance sheet at 1 July 2019.
Question 2: Should the company recognise deferred taxes arising on transition to AASB 16 in opening retained earnings?
Interpretive response: Yes, any deferred tax impacts on transition to AASB 16 should be recognised in retained earnings at 1 July 2019, the date of initial application, as the company is applying the modified retrospective method. This is consistent with the general principle in AASB 112 that recognition of deferred tax balances should follow the related item – i.e. the underlying ROU assets and lease liabilities are recognised against retained earnings.
In the above scenario, because the net carrying amount of the ROU asset and the lease liability is $100,000, there is a net deductible temporary difference of $100,000 given the net combined tax base of the ROU asset and the lease liability is nil. The company would recognise a deferred tax asset of $30,000 ($100,000 x 30 percent) at 1 July 2019 with a corresponding adjustment to retained earnings.
After implementing AASB 16, the company enters into a new lease to use a warehouse for 10 years. The company calculates that its lease liability and ROU asset for the warehouse lease is $800,000. The tax base of the warehouse lease is nil. So a taxable temporary difference of $800,000 arises on the asset, and a deductible temporary difference of $800,000 arises on the liability.
Question 3: Does the initial recognition exemption* for deferred tax in AASB 112 apply to the new lease entered into after the adoption of AASB 16?
Interpretive response: No. The application of the initial recognition exemption on entering into this lease is not appropriate as there is a net temporary difference of zero at the commencement date of the lease. Subsequent to the commencement date, deferred tax would be recognised for the net temporary difference that arises due to the differing amortisation profile of the ROU asset and lease liability. That is, a deferred tax asset or liability will be recognised for the net temporary difference at future reporting dates.
Current tax and deferred tax are recognised outside profit or loss if the tax relates to items that are recognised, in the same or a different period, outside profit or loss [AASB 112:58, 61A and 62A].
If a lessee applies AASB 16 under the modified retrospective method, it recognises the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings at the date of initial application [AASB 16:C7].
*Deferred tax liabilities and deferred tax assets are recognised for all temporary differences except those arising from:
The International Accounting Standards Board is in the process of preparing an amendment to IAS 12 (the IFRS equivalent of AASB 112) which will specifically state that the initial recognition exemption is not applicable to transactions that give rise to both taxable and deductible temporary differences, to the extent the amounts recognised for the temporary differences are the same.
If you would like to discuss the implementation of the new standard for your organisation, please contact us.