IFRS 16 approaches and the new tax regime for leased assets is in gestation. We focus today on the taxation of leases.
The consultation period has ended for responding to HMRC’s publications Leasing: Tax response to accounting changes and Corporate Interest Restriction: Tax response to accounting changes for leasing. In these HMRC provided clarity around a number of the proposed changes. A significant new tax test has been suggested to distinguish between IFRS 16 leases with ‘finance lease’ features and other IFRS 16 leases. This test would continue to allow non-long funding IFRS 16 leases. Also, it is needed to allow sale and leasebacks of property to fall outside the ‘Type 1’ financing arrangement rules - assuming they are not ‘tax finance leasebacks’. This new test is likely to require a lessee to apply judgements similar to those exercised at present in order to differentiate an operating lease and a finance lease. This is one of the key areas where we await fuller details when draft legislation is released in the summer.
Some of the big issues lie away from plant and machinery. Most companies which are non-long funding operating lessees e.g. of property will experience a move under IFRS 16 to tax relief for depreciation and finance charge. This will give some up-fronting of relief – how much depends on the discount factor chosen. If the starting liability is higher than the related asset, HMRC propose to give relief for the write-off as if the asset and liability had been equal. Significantly the current proposals would require parallel accounting records for tax. It has been suggested to HMRC that a more acceptable modus operandi to delay relief would be to calculate a difference and write it off straight-line over a fixed period of say 10 years akin to the loan relationship rules. We do not know if this suggestion will be adopted.
As expected the long funding lease (LFL) rules are being preserved with some minor tweaks.
Because an IFRS 16 lease is a different classification from an operating lease, there is a problem area for LFL operating lessees moving to IFRS 16. They are disadvantaged compared to FRS 102 lessees. The reason is that they have a deemed disposal and reacquisition of the assets on moving to IFRS 16. It will almost certainly be the case for an operating lease that the remaining present value of minimum lease payments (PVMLP) will be less than the disposal value at the time when IFRS 16 is adopted. This will give rise to a timing disadvantage as the ‘clawback’ of this difference would otherwise have occurred at the end of the lease term. A material balancing charge may arise depending on the size of the pool. The timing of this charge could not have been anticipated by the taxpayer when they entered into the lease.
The situation is worse for a taxpayer who was entitled to a first year allowance on entering into the lease.
To mitigate the impact of balancing charges arising as described above, we have suggested to HMRC that they might wish to consider allowing deferral of the taxation of balancing charges until the period of account in which the actual lease terminated. There is of course no guarantee this relief will be granted by HMRC.
Another specific issue is for long funding operating lessees of ships where the original lease was entered into before 1 January 2011. Capital allowances are currently available to such lessees at 18 percent. However, upon a deemed lease termination and reacquisition, expenditure under the ‘new’ lease will be long life asset expenditure and will only qualify for capital allowances at the lower rate of 8 percent. Again it might be possible to introduce some grandfathering measure to prevent this slowing down of relief.
For further information please contact: