CFM97815 - Interest restriction: leasing: IFRS 16 examples

Example 1 – Operating Lease

A Ltd prepares financial statements under IFRS. It rents property for use in its trade and classifies the property lease as an operating lease under IAS 17. From 1 January 2019, A Ltd adopts IFRS 16.

CIR treatment:

For the year ended 31 December 2018, A Ltd classifies the lease as an operating lease and includes the lease costs as rental payments in its income statement. For CIR, because this is an operating lease, no amount is included as a tax-interest expense.

For the year ended 31 December 2019, A Ltd accounts for the lease as a right-of-use lease. A Ltd will now recognise two amounts in its income statement – a depreciation charge and an interest expense on the lease liability. The CIR rules require A Ltd to consider whether the lease would be an operating lease or a finance lease, as if it had used an accounting standard that required it to differentiate between the two. Because the lease would have been classed as an operating lease under IAS 17 or FRS 102, neither the depreciation nor the interest expense is included as a tax-interest expense for CIR.

Since the lease had already been previously classified as an operating lease, unless the terms of the lease changes, A Ltd need not carry out an actual accounting classification test in the year ended 31 December 2019; A Ltd can simply continue to classify the lease as an operating lease for CIR purposes.

For both tax-EBITDA and group-EBITDA, no capital expenditure adjustment should be made for a depreciation charge on a lease that would have been an operating lease under IAS 17 or FRS 102. This is because the amount is essentially a rental payment and not capital expenditure

Example 2 – Finance Lease

B Ltd prepares financial statements under IFRS. It leases machinery for use in its trade and accounts for this as a finance lease under IAS 17. From 1 January 2019, B Ltd adopts IFRS 16. Under IFRS 16, the measurement methodology of the interest expense is different from that under IAS 17.

CIR treatment:

For the year ended 31 December 2018, B Ltd classifies the lease as a finance lease. The machinery is shown as an asset on the balance sheet and the income statement includes debits of £750k for depreciation and £300k as the finance charge. For CIR, because this is a finance lease, the £300k finance charge is included as a tax-interest expense (TIOPA10/S382).

For the year ended 31 December 2019, B Ltd accounts for the lease as a right-of-use lease. The machinery is shown as an asset on the balance sheet and the income statement includes debits of £800k for depreciation and £250k as the interest expense. The new CIR rules require B Ltd to consider whether the lease would be an operating lease or a finance lease, as if it had used an accounting standard that required it to differentiate between the two. Because the lease would have been classed as a finance lease under FRS 102, the £250k interest expense is included as a tax-interest expense.

It does not matter that the measurement under FRS 102 (or any other standard) would have been different, only the classification is used to determine whether or not an amount ought to be included in tax-interest for CIR purposes. The measurement, i.e. the amount of finance cost to be included in tax-interest, is taken from the current accounting standard, IFRS 16.

Example 3 - Exception

C Ltd prepares financial statements under IFRS. It leases laptops for use by employees in its trade and accounts for them as a finance lease under IAS 17. From 1 January 2019, C Ltd adopts IFRS 16. Under IFRS 16, C Ltd considers that the laptops meet the requirements of IFRS 16 to apply the election for leases for which the value of each underlying asset is low. Each individual laptop is not highly dependent on, or highly interrelated, with other assets. C Ltd applies the low-value election under IFRS 16 to the laptops, which have total rental payments of £300k.

For the year ended 31 December 2018, C Ltd accounts for the leases as a finance lease. The laptops are shown as an asset on the balance sheet and the income statement includes debits of £250k for depreciation and £100k as the finance charge.

For CIR, because this is a finance lease, the £100k finance charge is included as a tax-interest expense (TIOPA10/S382).

For the year ended 31 December 2019, C Ltd has elected to apply the low-value election for the laptop leases. It does not include the laptops on its balance sheet as a right-of-use asset, and the income statement includes a debit of £300k for rents payable (and no interest expense).

For CIR purposes, because the exemption applies and the lease is not a right of-use-lease under IFRS 16, the classification test should not be applied. There is no finance cost relating to the laptops in the income statement that can be included as a tax-interest expense.