Operating Leases – all change in the future?

For companies that have adopted IFRS, the next major challenge for many will be IFRS 16: Leases. This will apply for accounting periods beginning on or after 1 January 2019, with early adoption permitted.

Why will this be a challenge?

IFRS 16 removes the concept of the operating lease, seen as off-balance sheet financing, and thereby aims to provide comparability between companies’ financial statements regardless of their financing model.

There is an introduction of a “right to use” principle under which lessees will recognise an asset reflecting their right to use the leased asset for the leased term and a lease liability reflecting their obligation to make lease payments. Both the asset and lease liability will be recognised on-balance sheet at the commencement of the lease.

The lease liability is calculated at the present value of the lease payments discounted at the rate the lessor charges the lessee or, if this cannot be readily determined, the lessee’s incremental borrowing rate. In subsequent years, the liability is increased by the unwinding of the discount and reduced by the lease payments made by the lessor.

The lease asset is calculated as the present value of the lease payments, as calculated for the liability above, plus any direct costs, any lease payments made to the lessor before the lease commencement date, less any lease incentives received. The asset will then be amortised over the life of the lease and tested for impairment, where necessary. The lessee can choose to revalue such assets, but this should apply across all right-to-use assets of the same type.

It sounds like a lot of work, are there any exemptions and what type of companies are likely to be affected most?

IFRS 16 will be applied to all leases except for those with terms shorter than 12 months and for low value leases e.g. a stand-alone printer / photocopier (a suggested asset value was (USD) $5,000).

Companies in transportation services have traditionally used operating leases to finance their fleets of vehicles, with airlines being the most notable. But this will similarly affect logistics company with fleets of delivery vehicles on operating leases or companies with car fleets for their sales force or for rental. Retail operations are also likely to see wholesale changes to their balances sheets as their shops are brought under this system.

How will the tax landscape change in response to IFRS 16?

This has yet to be seen, but the changes are expected to be announced in the Finance Bill 2018 for 2019 implementation. HMRC have said that they are aware of the changes and are likely to be implementing anti-avoidance legislation to ensure companies do not try to take advantage of the accounting modifications.

The only issue may be that HMRC will want to keep the tax treatment comparable across all UK sited companies and therefore the tax treatment may impact on companies applying UK GAAP.

 

Blog author: Mark Hancock

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