Are you doing business in leased premises? If yes, then this article may be a good read for you. There is a new accounting standard (“new rule”) that require a different way of accounting for leased assets including your office premises. The new rule is called “IFRS 16 Leases” or simply “IFRS 16”. The acronym IFRS stands for “International Financial Reporting Standards”. IFRS 16 applies for entities for accounting years started 1st January 2019 or after. IFRS 16 has come with some tax uncertainties or risks that need to be managed. However, this article is not intended to discuss the technical details of how to account for leases under the new rule or tax purposes. Just a reminder that there is a new accounting rule that needs your closer attention as the year 2019 closes, and it may impact on your income tax liability and disclosure.
A decision whether to buy an asset or lease from others can be critical to the business. It is also critical for tax. The decision can make a difference as to the amount as well as the timing of tax liability. While building or purchasing your office building can be expensive and may take time, renting is relatively faster, and the periodic rental payments may not be as painful. So, doing business in rented premises is quite a normal business practice. Other assets (like equipment or vehicles) can also be accessed by way of a lease rather than purchasing.
Under a lease transaction, a tenant (or lessee) enters into a lease agreement with the landlord (or lessor). The lease agreement, essentially, creates rights (assets) and obligations (liabilities) for the parties involved. At the start of a lease a lessee obtains the right to use an asset for a period and, if payments are made over time, incurs a liability to make lease payments. The new rule is meant to ensure more transparency on these rights and obligations. The old rule (“IAS 17 Leases”), did not require specific disclosure of these rights and obligations in the balance sheet by entities. The absence of information about leases on the balance sheet meant that investors and analysts were not able to properly and easily compare companies that borrow to buy assets with those that lease assets.
Under the new rule, the distinction between operating leases and finance leases disappears for the lessee. Instead, a right-of-use asset and lease liability are recognized in respect of all leased assets including assets leased under what would be an operating lease under IAS 17. Under the new rule also, rental expenses are no longer reported in the income statement. Instead, two new expense items will be reported. An interest expense (reflecting, in substance, the financing aspect of the lease to the lessee) and a depreciation charge (for the right-of-use asset). Unfortunately, the income tax law has not changed. The tax rules, essentially, still reflect the old accounting rule (IAS 17). How taxpayers should now reconcile the two sets of rules is likely to be challenging and a new source of future tax disputes between taxpayers and the tax authority (TRA).
Will these new expense items be acceptable for tax deduction? Maybe not! But then, what will and how the same can be reflected in financial statements? Unfortunately, on this matter, there are no specific guidelines to taxpayers from TRA that I am aware of. For businesses with a significant amount of leased assets such as banks (leased branches) and telecoms (leased towers), one option is to seek a private or class ruling from TRA.
By Shabu Maurus, Tax Partner, Auditax International.