An insight into the new tax rules contained in the government’s draft Finance Bill.
After two decades in the making, most large companies in the UK will be adopting the new IFRS 16 lease accounting standard from next January. For finance teams that not only means potential headaches while they bed in accounting system changes, but also a raft of new tax rules contained in the government’s draft Finance Bill.
The new tax rules are due to come into force from 1 January 2019 (although they will not be enacted until some time in March) and the changed code presents companies with some interesting choices. In part this arises from the choice under IFRS 16, of different routes to adopt the new standard.
For example, companies may boost future P&L earnings by taking a one-time equity hit on the adoption of IFRS 16, rather than reflecting that charge as future depreciation of a “right-of-use” asset. However companies which choose to adopt the new standard in this way will only achieve that P&L enhancement at the cost of greater tax complexity.
Normally a cost taken to reserves on a change of accounting policy would attract immediate tax relief. However, the Treasury is unwilling to give immediate relief for the full transitional adjustment. The system HMRC recently unveiled involves a multi-stage weighted-average process to establish the period over which tax relief will be given. This requires a company to identify, on an asset-by-asset basis, the amount of transitional adjustment and the length of the remaining lease term. This might be a one-off exercise, but it will require a significant level of management’s time or external support for any business with a number of leased assets.
Don’t forget GAAP just yet
IFRS doesn’t deliver a complete break from the past. Specialist GAAP accountants – who might have been expecting to spend more time on the golf course - will remain in demand. That’s because HMRC decided lessees would still need to apply UK GAAP to new, as well as existing, leases in order to establish whether these are operating or are finance in nature. Right now, we have no indication of what HMRC will do if UK GAAP (FRS 102) adopts IFRS principles, but it would be surprising if it happens within the next five years.
The reason such ‘double accounting’ is needed is to give certainty of tax treatment; broadly it protects IFRS 16 lessees from falling into anti-avoidance traps and revenue raising provisions aimed at finance lessees.
Finance teams might have been worried that moving to IFRS 16 would trigger tougher restrictions in the tax deductions allowed under the corporate interest restriction (CIR) rules - given that IFRS 16 leases all have a “finance charge” element - this was a reasonable concern. Those affected will be pleased to know this won’t be the case.
A solid set of changes
Broadly speaking, HMRC’s changes to the tax code on IFRS 16 is good news. After a two-year consultation period, the tax authorities seem to have avoided accidently triggering any tax traps and have also succeeded in simplified things such as its tweaks of the rules around long-funding leases.
The main negative will be the cost of maintaining two accounting systems in parallel – a significant burden for companies which might have hundreds or even thousands of leasing contracts.
The big challenges for finance teams from next year will be to first institute a system that can continue to track operating and finance leases; and a second one that gathers data on transitional adjustments in order to obtain clarity on what their current and deferred tax will be.
Interested parties have until 31 August 2018 to send comments about the draft Finance Bill to HMRC.