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Is the right to use subsurface space a lease?

Is the right to use subsurface space a lease?

Entities may enter into agreements for subsurface rights. Typically this involves obtaining the right to place items (such as pipelines or cables) in an underground space. Such arrangements are common in the telecommunication, power and utilities, oil and gas and mining sectors, as well as for companies with significant land ownership. Where these occur above ground they are often referred to as ‘way leaves’ or ‘easements’.


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In June 2019, the IFRS Interpretations Committee (IFRS IC) issued an agenda decision regarding subsurface rights. The decision outlines that a specified underground space is physically distinct from the remainder of the land where such space is explicitly defined in the contract. Together with other facts contained in the scenario, the IFRS IC noted that the agreement contained a lease.

We consider the impact of AASB 16 Leases on the fact pattern considered by the IFRS IC, as well as other scenarios which are common in practice.

Scenario considered by the IFRS IC

The IFRS IC considered the following facts:

  • The customer has the right to place an oil pipeline in an underground space for 20 years in exchange for consideration.
  • The contract specifies the exact location and dimensions (path, width, depth) of the underground space.
  • The landowner retains the right to use the surface of the land above the pipeline but cannot access or change the use of the specified underground space.
  • The customer has a right to access the land to perform inspection, repairs and maintenance (including replacing damaged sections of the pipeline when necessary).

Question 1

Does the agreement contain a lease under AASB 16?

Interpretive response: Yes, based on the scenario above, the IFRS IC considered the arrangement to be a lease because:

  • There is an identified asset: the underground area is physically distinct from the remainder of the land. The landowner does not have the right to substitute the area throughout the period of use. 
  • The customer has the right to obtain the economic benefits from using the subsurface area, since it has exclusive use of the space. 
  • The customer has the right to direct the use: the IFRS IC considers that the “how and for what purpose” decisions are predetermined in the agreement. As such, the assessment looks to whether the company has the right to operate the underground land without the landowner having the right to change those operating instructions. In this case, the IFRS IC considers this to be the case as the landowner is prohibited from accessing the underground space, and the customer makes the decision about the use of the underground land during the period of use.

Alternative scenarios

The IFRS IC decision considered a narrow fact pattern. In practice, there are many variations of the scenario above that could change the assessment, for example:

  • The exact location and dimensions of the underground space are not explicitly defined. In this case, judgement is needed to determine whether the space is implicitly identified when made available for use. A lack of contractual specificity may indicate there is no identified asset, since the customer could be viewed as having shared use of the entire land.
  • The landowner can require the customer to move its pipeline to another part of the subsurface land. Whether this substitution right is ‘substantive’ can be difficult to establish, as a customer will often not be privy to whether the landowner has a practical ability to make another space available, and whether the landowner would benefit economically from doing so. Where a customer cannot establish this, it must assume the substitution right is not substantive. In this case the arrangement would be a lease if the other lease definition criteria are met. 
  • The customer is prohibited from accessing the space other than in emergencies. This may indicate the customer does not control the area. However, it may be that pipeline or cable is controlled remotely, and physical access is not required in order to direct the use of the space. 
  • The ongoing decisions over how and for what purpose the space is used are shared between the customer and the landowner. In this case, judgement is needed to determine – on balance – which party controls the use of the asset, taking into account all facts and circumstances. It will be important to understand which of the ongoing decisions are most important in deriving economic benefits from the space. For example, decisions over the size and type of pipe are likely to be highly influential on economic returns; whereas decisions over the colour of the pipe are negligible. The party making decisions which are most impactful on economic returns is the party controlling the use of the asset.
  • The contract includes the use of shared areas which are not physically separate from the sole-use space. In this case, it may be challenging to identify the unit of account for the lease assessment, such as identifying a demarcation point between the potentially leased space and the shared area. A lack of contractual or physical separation could lead the customer to conclude the unit of account is the entire land, in which case it is unlikely to be a lease. If the contract does contain a lease, it will be necessary to determine whether the shared areas are a separate non-lease component (see Question 3 below).

Question 2

Is there a difference in accounting under US GAAP?

Interpretive response: There may be a difference in analysing the scenario above under US GAAP. There are presently mixed views on whether a lease exists. One view considers that the subsurface land is identifiable and can be leased, whilst the other equates the subsurface land to air-use rights. Air-use rights are explicitly identified under US GAAP as an intangible asset and are therefore out of scope of the leasing standard.

Question 3

What other issues need to be considered?

  • In some situations, the term for these arrangements may be for a long period of time that could appear to be perpetual. Entities will need to carefully consider whether the term is indeed perpetual or has a specified term, as perpetual leases are out of scope of AASB 16 (given that they do not have a finite period of use). 
  • Some agreements may include multiple lease components (e.g. lease of above ground and subsurface land) or both lease and non-lease components (e.g. dedicated and share space). Where there are multiple components, payments are allocated to each component on the basis of their relative standalone prices.

There may be significant judgement and effort involved in determining whether each component is separable, and if so, deriving standalone prices. As a practical expedient, companies may elect not to separate lease and non-lease components, however this would effectively capitalise services as right-of-use assets and lease liabilities.

In technical speak

A contract contains a lease if the contract conveys the right to use an identified asset for a period of time in exchange for consideration [AASB 16:9].

An identified asset can be explicitly specified in the contract or implicitly specified at the time the asset is made available for use. [AASB 16: B13].

A customer does not have the right to use an identified asset if the supplier has a substantive right to substitute the asset throughout the period of use. A right to substitute is considered substantive only if both of the following conditions are met:

  • The supplier has the practical ability to substitute alternative assets, e.g. customer cannot prevent the supplier from substituting, alternative assets are readily available or can be sourced within a reasonable period of time by the supplier.
  • The supplier would benefit economically from exercising its right to substitute the asset. [AASB 16: B14].
    A capacity portion of an asset is an identified asset if it is physically distinct or represents substantially all of the capacity of the asset. [AASB 16: B20].

To control the use of an identified asset, a customer must have the right to obtain substantially all of the economic benefits from the use of the asset through the period of use. An example is by having exclusive use of the asset throughout that period. [AASB 16: B21].

A customer has the right to direct the use of an identified asset in either of the following situations:

  • The customer has the right to direct how and for what purpose the asset is used throughout the period of use; or
  • The relevant decision about how and for what purpose the asset is used are predetermined and:
  • The customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the period of use, without the supplier having the right to change those operating instructions; or 
  • The customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose of the asset will be use throughout the period of use. [AASB 16: B24].

For contracts which contain a lease component and one or more additional lease or non-lease components, a lessee shall allocate the consideration to each component based on the relative standalone price for each lease component and aggregate standalone price for non-lease components. [AASB 16: 13].

A lessee may elect, by asset class, not to separate lease and non-lease components and instead account for each lease component and associated non-lease components as a single lease component. [AASB 16: 15].

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