Aligning tax with accounting for leases
Aligning tax with accounting for leases
The Government is proposing a law change in early 2020 to allow lessees to follow the treatment in a new lease accounting standard (NZ IFRS 16) for tax. This will apply for tax years commencing on or after 1 January 2019, to mirror the application of NZ IFRS 16.
Read the proposed law change here.
What's changing for accounting?
NZ IFRS 16 replaced the former lease accounting standard, NZ IAS 17.
NZ IAS 17 distinguished between operating and finance leases, the latter being one that effectively transfers ownership of the leased asset to the lessee.
New NZ IFRS 16 applies to all leases so a lessee must recognise a new balance sheet asset – being the right to use the leased asset for the lease term – and a lease liability (being the obligation to pay rentals). NZ IFRS 16 accelerates the accounting expense but does not change the overall lease expense over time. It affects the balance sheet as new assets and liabilities are recognised.
Current tax treatment
The tax rules distinguish between an operating and finance lease (albeit the boundary is drawn differently to NZ IAS 17):
- Tax finance leases are treated as a financial arrangement, with lease payments treated like a repayment of a loan with interest expense for the lessee.
- Payments under a tax operating lease, in contrast, must be spread over the life of the lease.
The tax proposal
The tax distinction between finance and operating leases will continue but lessees will be able to make an irrevocable choice to follow their NZ IFRS 16 accounting treatment for tax operating leases.
The detail, including some issues to still be worked through, includes:
- The choice will be made at the time of tax return filing.
- The proposal does not apply to leases of real property (i.e. land and buildings). It is proposed that the current operating lease tax treatment would continue. A similar result will apply to leases from an associate and subleases.
- Adjustments are proposed to the accounting timing for certain lease accounting items (such as impairments of the lease right to use) so that tax deductions are available only when the lease expenditure is actually incurred. That may bring forward or delay expenditure for tax, compared to NZ IFRS 16.
- A tax finance lease can continue to apply the financial arrangements spreading rules (the yield to maturity method) rather than the NZ IFRS 16 method.
- There will be a transitional adjustment, with either deductible expenditure or taxable income, in the first year IRFS 16 is followed for tax. A similar tax adjustment will apply if IFRS 16 ceases to be applied or the lease ceases to be within scope.
- There will be no change to the tax treatment for the lessor.
- For non-IFRS taxpayers, there will be no change in the tax treatment for either the lessor or lessee.
An initial view
Aligning the tax and accounting timing for leases is attractive. It minimises compliance costs. However, the proposal still requires taxpayers to track what is happening in their accounts to be able to make adjustments for certain accounting expenses. This reduces the benefit of the proposal, in our view. Whether the election will be worthwhile will depend on your view of how likely and how often adjustments to the accounting amounts will need to be made. Similarly, taxpayers who lease buildings will still have compliance costs from having to track these separately from other leased assets.
NZ IFRS 16 will require additional balance sheet amounts to be recognised. If the thin capitalisation rules apply, the impact of increased assets and liabilities is not dealt with in the proposal. As the amortisation of the asset and liability will not match (i.e. “depreciation” is more likely to follow a straight line while the repayment of the loan is normally delayed) there may be unexpected impacts on the thin capitalisation ratio. This should be modelled as part of your transition to NZ IFRS 16, particularly for those sitting close to the thin cap thresholds.
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