Recent updates in 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 of prospective changes to FRS 102 lessee accounting
The FRC announced in late 2022 December that FRS 102 (UK GAAP) lessee accounting will change in order to come in line with IFRS 16. This is now expected to happen from 1 January 2026. I have previously given my thoughts on what this is likely to mean for lessees' tax treatment.1
Now following an announcement in the 2023 Autumn Statement we are expecting draft legislation on allowing lessors to claim 100% first year capital allowances - "full expensing" - on their expenditure. Full expensing has already been made permanent for qualifying new assets. Currently however there is a longstanding ban on lessors claiming first year allowances such as full expensing. Some lessees are able to claim full expense relief but only under hire purchase contracts or long funding leases (typically these are finance leases of over 7 years). If a lease is 7 years or shorter, in a nutshell no one benefits from the full expense incentives. Government is rightly keen to ensure that this valuable incentive can be used in wider circumstances, which is why they are considering allowing lessors in these situations to claim the first year allowance. The new rules are not yet published in detail but all our fingers are crossed for rapid progress. If this happens, we expect to see a resurgence of leasing as a means of financing plant and machinery. Lessees who cannot use a first year allowance themselves (e.g. because of tax losses) ought to find that it is beneficial to tap into lessors' tax capacity. Leasing should be preferable to loan finance for these asset users because a lessor who claims a 100% FYA on a £100 asset purchase immediately recovers £25 in tax and in essence they are only then funding a “loan” of £75 as opposed to £100. Even where an asset user can utilise the tax relief themselves, leasing may enable them to borrow a greater percentage of the asset cost.
What would this mean - no changes to my comments below, just my crystal ball reflects many more leases and therefore a wider number of right-of-use lease issues under FRS 102 when FRS 102 changes following FRED82. Interesting times!
Related Insights
1Some of my earlier thoughts on the tax implications of FRS 102 moving to a right-of-use model:
The right-of-use concept proposed by FRED 82 is essentially the same as IFRS 16 lessee accounting, barring some relatively small differences. 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 my experience, a major part of the challenge when companies moved operating leases to a right-of-use basis 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 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 adjustments when FRS 102 changes.
As yet we still 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 FRS 102 right-of-use leases. The position for IFRS 16 right-of-use asset 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 right-of-use leases will be treated the same.
As with IFRS 16 there will be several deferred tax points arising from transition or from the new treatment:
- A transitional adjustment taken to reserves which is tax deductible over a period should give rise to a DTA (or DTL in the event of a net credit)
- Otherwise deferred tax should not arise as tax follows P&L, however
- In the case of intra-group leases, a deferred tax balance is likely to arise because the tax base of the right-of-use asset and lease liability will each be different in the group accounts compared to the solo accounts.
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.