The International Accounting Standards Board’s new international accounting standard on leases, IFRS 16 Leases (“IFRS 16”), will shortly be coming into force in respect of periods of account beginning on or after 1 January 2019. For lessees, the new standard has important implications, bringing most leases on-balance sheet, while eliminating the dichotomy between finance leases and operating leases. Lessor accounting under IFRS 16 will be mostly unchanged.
In response to IFRS 16, HM Revenue & Customs (“HMRC”) have proposed a number of changes to existing tax legislation, especially in respect of rules which rely on the existing finance and operating lease dichotomy.
Repeal of Section 53 Finance Act 2011 (“FA 2011”)
Section 53 FA 2011 was introduced as a temporary measure to provide certainty in respect of the taxation of leases. It requires IFRS 16 adopters to keep separate records for tax and accounting in respect of each lease, by ensuring that leases continues to be taxed based on the distinction between finance and operating leases.
HMRC have confirmed that section 53 FA 2011 will be repealed for periods of account beginning on or after 1 January 2019. Any transitional adjustments in respect of affected leases will be spread over the weighted average remaining length of leases as at the date of transition.
Key Changes to the Long Funding Lease (“LFL”) Regime
HMRC have confirmed that the rules for determining the capital expenditure for a Long Funding Finance Lease should apply to all LFLs, which would include finance leases under existing UK GAAP (i.e. FRS 102) or any leases under IFRS 16. Therefore, the capital expenditure in respect of all LFLs will be determined using the “commencement PVMLP” (i.e. present value of the minimum lease payment) approach under section 70C of the Capital Allowances Act 2001 (“CAA 2001”). Conversely, the approach under section 70B CAA 2001, which provides that the capital expenditure for a Long Funding Operating Lease is to be determined by reference to the market value of the plant and machinery at the start of the lease or when it is first used, will not apply to leases under IFRS 16.
The definition of short leases, which fall outside of the LFL regime, will be simplified to include all leases for a term of seven years or less.
No new definition based on the question of the transfer of risks and rewards of ownership will be introduced into the LFL regime. Instead, continued reliance will be placed on the lease payments test in section 70O CAA 2001 and the useful economic life test in section 70P CAA 2001 to identify a LFL. In the rare instances in which a lease over seven years, treated as a finance lease by a lessor, does not meet either of the tests in sections 70O or 70P CAA 2001, neither the lessor nor the lessee will be entitled to claim capital allowances in respect of that asset.
To side step the problems which section 70YA CAA 2001 might cause by treating an existing lease as terminating and a new one as beginning from the point that IFRS 16 comes into force, HMRC have confirmed that grandfathering provisions will be introduced to tax any LFL held when section 53 is repealed under the same rules as before (without any disposal or acquisition).
HMRC intend to include the above changes in the next Finance Bill. It is anticipated that these changes will be effective in respect of accounting periods beginning on or after 1 January 2019.
HMRC’s Policy Paper and draft legislation published on 6 July 2018 can be found here.