Over the summer, HMRC has been consulting on possible changes to the tax rules for the leasing of plant or machinery. The driver for this change is the forthcoming introduction of the IASB's new lease accounting standard, IFRS 16, which will have effect for periods of account beginning on or after 1 January 2019 (with early adoption permitted in certain cases).
The use of IFRS is compulsory for the consolidated accounts of certain publicly quoted groups. However, the majority of UK companies use FRS 102 for their solus company accounts; in which case IFRS 16 will not be relevant to them for tax purposes. Nevertheless, the consultation will affect all UK tax-paying lessors and lessees of plant and machinery. It is worth noting at the outset that this consultation does not propose any changes to the tax treatment of lessors or lessees of land.
IFRS 16 – the background
Under IFRS 16, lessees will no longer classify their leases as being either "finance" or "operating" leases. Rather, lessees will account for all leases in the same way as they currently account for finance leases. That will apply to all lessees, whether the lease is of land, plant and machinery or otherwise, unless either the term is 12 months or less or the lease is over low value assets (guidance suggests less than $5,000). Under this approach, the lessee will record on its balance sheet: (i) a "right of use" asset; and (ii) a liability to pay rentals under the lease, both valued at the outset by reference to the present value of the payments under the lease. That will increase the gross assets and gross liabilities on the balance sheets of lessees. The right of use asset will then be depreciated over the term of the lease, normally on a straight line basis. The rental payments will be treated by the lessee as, in part, reducing its balance sheet liability and in part as a finance charge element (computed at a constant rate on the outstanding liability). Turning then to the P&L of the lessee, that will show deductions for both the depreciation of the "right to use" asset and the finance charge.
Lessors will not be significantly affected by the new accounting standard, other than in relation to the disclosure requirements in their accounts. Since those disclosure changes do not impact the recognition and measurement requirements, that is of little or no import in this context.
FRS 102 (which is what now contains UK GAAP), often follows the lead of IFRS. However, it is not presently expected that it will converge with IFRS 16 until 2022 at the earliest.
HMRC Consultation Document
There is no immediate need to change the UK tax treatment of the leasing or letting of plant and machinery. However, IFRS 16 has provided impetus to the government to reconsider taxation in this area. The consultation document notes that in part that is because the leasing landscape has changed enormously over recent years as a result of the banks' reduced tax capacity, different players in the market and moving tax rates and reliefs. What the consultation document does not state is that the introduction in 2006 of the long funding lease rules hugely reduced the scope for tax-driven finance leasing while introducing what seems to us as an absurdly complex regime.
The options for changes to the UK tax treatment of the leasing or letting of plant and machinery set out in the HMRC consultation range from retaining the status quo (with minimal change to the statutory provisions to ensure that the current tax regime delivers the same outcome for tax purposes) to various options for full regime change which are based on the accounting entries albeit adjusted to some degree. Suggested adjustments to the accounting entries involve providing either an option to the lessee to claim enhanced or accelerated relief, or capital allowances, in each case based on the value of the "right to use" the leased asset.
It is worth reiterating that, although IFRS 16 will have effect for leases of both property and plant or machinery, HMRC's discussion document is concerned only with the impacts for leases of plant or machinery.
Timing of changes
The consultation closes at the end of this month but marks only the start of the process of developing tax policy in this area. HMRC has, as yet, expressed no preference for any of the options set out and the questions posed in the document are couched in very broad terms, specifically acknowledging that the options are not exhaustive.
We assume that any new rules would not be introduced prior to IFRS 16 in 2019, which gives businesses time to consider how their lease funding could be affected under the potential options for change and to plan for any future acquisitions of plant and machinery.
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