Changes to UK GAAP lease accounting

Thoughts on the likely tax impacts of prospective changes to FRS 102 lessee accounting

Thoughts on the likely tax impacts

The Financial Reporting Council (FRC) announced in December 2022 that FRS 102 (UK GAAP) lessee accounting will change in order to come in line with IFRS 16. This could happen from 2026 or soon after. So what might this imminent change mean for those looking after businesses’ tax returns?

For possible answers to this question we can look back to 2019 when companies who use IFRS or FRS101 adopted IFRS 16. The on-balance sheet approach proposed by FRED 82 is essentially the same as IFRS 16 lessee accounting, barring certain expedients yet to be finalised. HMRC’s response to IFRS 16 was to introduce specific tax legislation in Finance Act 2019: this legislation is still with us, and it appears fit for purpose in dealing with the changes proposed to FRS 102.

In our experience, a major part of the challenge when companies moved operating leases to an on-balance sheet approach was remembering that the basic principles of taxation had not changed – we might need to follow different looking P&L accounting entries for tax purposes, however, it remains true that rentals are deductible on revenue account and certain other items (which may find their way into a right-of-use asset) are still not deductible. 

A big compliance burden for some companies on the move to IFRS 16 was the tax spreading rules. These were designed to ensure that transitional accounting adjustments were tax effected over a company’s weighted average remaining lease term. Some major exercises were called for in cases where companies had hundreds or even thousands of separate leases of premises, for example in the retail sector. We expect these spreading rules will automatically apply if companies have transitional accounting adjustments when FRS 102 changes.

As yet we do not have the final standard. HMRC are waiting for this and have not yet made announcements of any new tax rules. It would be surprising, however, if they make changes to the legislation which is already on the statute books and is capable of dealing with right-of-use leases. It is also reasonable to assume that ‘SP 3/91’ principles - for the timing of tax relief for finance lease rentals - will be explicitly extended to the tax treatment of rental payments under the amended FRS 102. The position for IFRS 16 on-balance sheet leases is covered in HMRC guidance (BLM 51000). We expect, in due course, HMRC will make changes to this guidance to confirm that FRS 102 on-balance sheet leases will be treated the same.  

Deferred tax issues are likely to arise from transition and from the new treatment.  These aspects will be covered by a separate note in future.

HMRC have indicated that, when it is clearer what the final version of the changes is, they will reach out to the Finance and Leasing Association (FLA) and other trade bodies, to open up communication. From that stage we should begin to obtain further clarity on HMRC’s plans and to look for any proverbial devils in the detail....