The new lease standard & tax
Peter van Tiggele
New accounting rules for lease accounting will be effective for annual reporting periods beginning on or after January 1st, 2019. These new regulations are laid down in IFRS 16 and in ASC842 for US GAAP. The standard prescribes that all leases should reported be reporting on the balance sheet. What does this mean for you as a tax specialist?
The new regulations introduced by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), will lead to a more realistic financial view of the balance sheet for all organizations. January 1st, 2019 is nearing rapidly and a lot of companies started project groups in order to comply with this new standard. The transitioning to the new reporting requirements will cost a lot of time, money, energy and can be very complex.
In practice, we often see that the finance department is in the lead of the implementation. However, there are a number of tax accounting aspects that need to be addressed as well.
Set up (deferred) tax-positions upon conversion
As a result of the new standard, companies will require to bring most leases on-balance sheet from January 1st, 2019, whereby assets (“Right of Use “) and the obligation to pay rent (Lease Liability) periodically will be calculated and reported on-balance. At the conversion time, an adjustment of the opening balance for equity will be required, since the new “Right of Use”-section will most likely not be equal to the Lease liability. As a consequence deferred or current tax position will have to be set up on this equity difference. The tax impact depends on the local tax law per country. Are you ready to provide tax guidance on the opening equity adjustment by country?
Determine tax treatment on leases per country
From 2019 all new lease contracts under IFRS and US GAAP will be reported on the balance sheet, except for leases with low value and leases with a term of less than one year. Most of the tax authorities allow a deduction when the invoice of the lease term is issued. This tax treatment will trigger a deferred tax position at the beginning of the lease for both the RoU-category and in the Lease liability. If tax RoU-assets or lease liabilities can be (partially) followed for tax, think also about the future course of these attributes. How can these tax attributes be monitored to ensure a correct tax accounting treatment? Preferably these differences will be recorded in lease accounting-software.
Upon implementation of the new lease standards, various balance sheet items need to be reclassified to the RoU-section or to the lease liabilities. The lease-assets currently reported in the headings “Property, Plant and Equipment” and “Investment property” will need be reclassified to the RoU-category. However, please also think about the balance sheet items: Intangibles, Step-Rent, Onerous contracts, Asset Retirement Obligations and Purchase Price Allocation. Part of these items may be lease-related and might be reclassified. Please don’t forget to monitor the tax treatment and how these tax attributes elements can be followed going forward!
The new lease standard has a major impact on the financial ratios and performance metrics, such as solvency, EBIT, EPS , and ROE and Operating cash flows. Balances will increase due to higher “RoU”-assets and higher debts “Lease Liability”. The income statement will change since the presentation of the costs changes by a higher EBITDA, more depreciation and interest charges. These changes may also affect credit ratings and bank covenants. In some cases, this may have consequences for the non-deductible interest under the 30% EBITDA-rule. As a consequence, organizations might reconsider the “lease versus buy”-strategy.
Lift along with finance ….
The implementation of the lease standard cost a lot of time, energy and money for the entire organization. However, don’t under estimate the tax accounting implications and start on time . Many organizations have purchased lease accounting software. It is efficient from a tax perspective to lift along with the finance project. Try to include the tax attributes in the finance software, so that the book and tax differences can be kept up-to-date. This to ensure a process smoother in January.