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Proposed changes to UK lease taxation

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Charles Yorke

Partner

London

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16 August 2016

HMRC published a discussion paper on 8 August 2016 setting out how the UK’s plant and machinery lease taxation rules might be changed in light of IFRS 16, the new accounting standard for leases.

Responses to the paper are required by 30 October 2016. Generally, the proposals are to move closer to an accounts-based regime. There is no comment about when any such changes might be implemented.

IFRS 16 was published by the International Accounting Standards Board on 13 January 2016.  Most significantly, IFRS 16 does not require lessees to distinguish between operating leases and finance leases. Instead, lessees are required to recognise both an asset (a right of use) and a liability (the obligation to pay rentals) on their balance sheets. The standard must be applied from 1 January 2019, although earlier adoption is permitted. The Financial Reporting Council has not yet indicated whether equivalent changes will be made to FRS 102 (that is, to UK GAAP).

The UK’s lease taxation rules currently include a provision that (for tax purposes) ignores changes in lease accounting standards, so that the tax rules would continue to apply by reference to SSAP 21 and IAS17. While this works in principle, it is complex and so this is about a longer-term solution. Changes will be needed because the distinction between long funding finance leases and long funding operating leases is a fundamental feature of the UK’s lease taxation rules, and the rules also contain numerous other references to the two different types of leases.

HMRC has suggested four different options:

  • Option 1 - Status quo

“Minimal change to the statutory provisions to ensure that the current tax regime continues to function and deliver the same outcome for tax purposes.”

This is the only option that has been proposed under which lessors would continue to be entitled to claim capital allowances if the lease is short.  All of the other options would simply require lessors to follow their accounts.

  • Option 2 – Accounts based regime

“A new tax regime based on the accounting entries.”

Under this option both lessors and lessees would simply follow their accounts. A particular concern here would be that this would create a material difference between the tax treatment of a lessee of plant and machinery compared with an outright owner funded by debt: the former would be entitled to tax relief for depreciation by reference to their accounts, but the latter by way of claiming capital allowances (often at a more advantageous rate).

  • Option 3 - Accounts based with leasing allowance

“A new tax regime based on the accounting entries but providing an option to the lessee to claim enhanced or accelerated relief based on the value of the right to use the leased asset.”

This is the same as option 2, save that the “ultimate” lessee would be compensated for the timing disadvantage referred to above by way of a “lease allowance” (which would be more generous than accounting depreciation).

  • Option 4 - Accounts based with capital allowances

“A new tax regime based on the accounting entries but providing an option to the lessee to claim capital allowances based on the value of the right to use the leased asset.”

This is the same as option 3, save that the “ultimate” lessee could elect to claim capital allowances rather than a special lease allowance.

Timing and summary

HMRC have requested responses by 30 October 2016. There is no mention of when a new regime might be implemented. The discussion paper notes that banks have largely withdrawn from the leasing market, and that now the market involves different types of investors such as investment funds. That said, there are still many old tax leases sitting on banks’ balance sheets, and we believe it will be important to ensure that any new regime does not impact these old transactions.

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