Changes to Accounting Standards for Leases
Who is likely to be affected?
Businesses which are lessees or lessors of assets and account for lease transactions using a leasing accounting standard which changes on or after 1 January 2011.

General description of the measure
Current accounting standards are International Accounting Standards (IAS) and UK Generally Accepted Accounting Practice (UK GAAP). Changes to the IAS lease accounting standard are expected during 2011, and changes to UK GAAP might follow in 2013. Legislation will be introduced in Finance Bill 2011 to ensure continuity of tax treatment for lease transactions for businesses which begin to account for the transactions under new accounting standards, expected to be introduced from 2011. The measure will require tax profits and losses to continue to be calculated as if the changes to lease accounting standards had not taken place.

Policy objective
The measure will ensure that existing tax rules that rely on accounting classifications of leases as operating or finance leases, and the accounting treatment of lease transactions, continue to operate in the way they currently do. The objectives are to: • • ensure that lessors and lessees will be neither disadvantaged nor advantaged by the proposed accounting changes; remove uncertainty for businesses about the future tax treatment of leasing contracts, arising from uncertainty about future lease accounting standards and their interaction with current tax rules; and protect the Exchequer.

•

Background to this measure
• • This measure has not been previously announced. Limited informal consultations with some representatives from industry, accountancy and legal bodies have taken place since April 2010.

Detailed proposal
Operative date
The measure will have effect where a business accounts for lease transactions using a lease accounting standard that is newly issued or is changed on or after 1 January 2011. The measure will be effective for any period where early adoption is permitted by the accounting standards.

Current law
Current tax rules differentiate between finance leases and operating leases. Apart from capital allowances, accounting entries normally govern what amounts are taxed and allowed as deductions (and their timing). The main exception to the broad principle above is the rules relating to long funding leases. The long funding lease rules treat a lease as if the lessor had disposed of the asset to the lessee with the purchase price left outstanding as a loan from the lessor to the lessee. Again, with the exception of capital allowances, accounting entries normally govern what amounts are taxed and allowed as deductions (and their timing). Current law also includes a number of anti-avoidance measures (for example, the sale of lessors legislation in Chapters 3 and 4 of Part 9 of the Corporation Tax Act 2010) intended to protect the Exchequer. The correct operation of some of these tax rules is dependent on aspects of the current accounting treatment.

Proposed revisions
Legislation will be introduced in Finance Bill 2011 to ensure that any business that accounts for lease transactions using a leasing accounting standard that is newly issued or changed on or after 1 January 2011 continues to apply all tax rules as if the changes to leasing accounting standards had not taken place.

Summary of impacts
Exchequer impact (£m) Economic impact Impact on individuals and households Equalities impacts The exchequer impact of this measure will be confirmed at the Budget. It is not expected to have any significant impact on receipts. This measure is not expected to have significant economic impacts. The measure affects businesses only and as such is not expected to have any impact on individuals and households. This measure is specific to those businesses engaging in leasing transactions. The measure will ensure that the current tax rules for leasing transactions will continue to operate as planned irrespective of changes to lease accounting. As a result there have been no ways identified in which it could impact unfairly on any equality group. This measure is not intended to change the current tax treatment of leases. However, it is likely that there will be an administrative impact from this measure. This will depend on accounting standards that businesses adopt now and in the future. Businesses will be impacted: • • during 2011, if they use IAS and voluntarily adopt the IAS new form of lease accounting expected to be issued; for other businesses using IAS, from the date the IAS new form of lease accounting becomes mandatory. This date is unknown and may be from 1 January 2012 or 2013; and

Impact on business including third sector

•

`for businesses using UK GAAP only if the UK GAAP lease accounting standard also changes. This may be as early as 2013 but could be delayed to 2015 and may not happen.

It is therefore not possible to estimate how many businesses may be affected. However, assuming 1 million businesses are affected, HM Revenue and Customs (HMRC) estimates that, without this measure, businesses could incur extra one-off administrative costs totalling approximately £200 million and extra on-going administrative costs of around £100 million per year. As a result of this measure, it is anticipated that businesses will incur substantially lower extra administrative costs estimated at one-off administrative costs of around £100 million and the extra on-going administrative costs of around £50 million per year. In the short term, before adoption of new accounting standards become compulsory, the administrative costs will be much lower. Assuming that 1,000 businesses voluntarily adopt the new IAS lease accounting standards early, the estimated combined initial one-off set up administrative costs for them in 2011 will be around £170,000 with combined recurring annual extra administrative costs around £80,000. HMRC also estimates that the legislation will avoid the need for some businesses to obtain clearances from HMRC on aspects of the application of existing tax rules under the new accounting standards, avoiding administration costs for each clearance of around £250 on average. Cost Compliance costs One-off Costs £ 100m When changes to lease accounting standards take effect Ongoing Time Period (yrs)

Average Annual Costs Total Costs (PV) Compliance benefits One-off Benefit Average Benefit

£ 50m

£0 Annual £ 0

N/A N/A

Total Benefit (PV) Net Benefit (NPV) The present value (PV) of total costs is dependent on when changes to lease accounting standards take effect.

Impact on Administrative Burden Increase £ 50m Decrease £0 Net Impact £ 50m

Impact on public sector Other impacts

The measure will maintain the current tax rules for leasing and as such no impacts are expected. Small Firms Impact Test: the measure is not expected to have a disproportionate affect on small firms and excluding firms/companies with fewer than 20 employees would not achieve the policy objective.

Monitoring and evaluation
The policy will be kept under review through regular communication with the business sectors affected by the measure.

Further advice
If you have any questions about this change, please contact Alison Bull on 020 7147 2595 (email: alison.bull@hmrc.gsi.gov.uk) or Paul Hindley on 020 7147 0429 (email: paul.hindley@hmrc.gsi.gov.uk).

Consultation draft

1

1 (1)

Leases and changes to accounting standards This section applies where there is a change in a leasing accounting standard which— (a) occurs on or after 1 January 2011, and (b) is not within subsection (3), (in this section referred to as a “leasing change”). “Leasing accounting standard” means— (a) International Accounting Standard 17 (leases) issued by the International Accounting Standards Board, (b) Statement of Standard Accounting Practice 21 (accounting for leases and hire purchase contracts) recognised by the Accounting Standards Board, (c) the part of the International Financial Reporting Standard for Small and Medium-sized Entities issued by the International Accounting Standards Board which relates specifically to leases, (d) the part of the Financial Reporting Standard for Smaller Entities issued by the Accounting Standards Board which relates specifically to leases, or (e) any accounting standard, or part of an accounting standard, which replaces (wholly or in part) a standard or part mentioned in paragraphs (a) to (d). A change is within this subsection if, and to the extent that, it is one which permits or requires persons, when preparing accounts in accordance with UK GAAP, to account for a lease, or a transaction accounted for as a lease, in a manner equivalent to that provided for by the International Financial Reporting Standard for Small and Medium-sized Entities issued by the International Accounting Standards Board (disregarding any leasing change which may be made to that Standard). Changes within subsection (1) include those which may or must be adopted for periods of account which fall wholly or partly before the time the change occurs or before the day on which this Act is passed. For the purposes of the Taxes Acts any reference in those Acts (other than this section)— (a) to a thing being determined or done in accordance with or by reference to generally accepted accounting practice, or (b) to accounts prepared (or not prepared) in accordance with international accounting standards or UK GAAP, is to be construed as if any leasing change had not occurred. Section 997 of ITA 2007 and section 1127 of CTA 2010 (meaning of “generally accepted accounting practice” and related expressions in the Tax Acts) have effect subject to subsection (5).

(2)

(3)

(4)

(5)

(6)

2 (7)

Consultation draft

Where a person first prepares or is required to prepare accounts in accordance with new standards for a period of account (“the relevant period”)— (a) subsection (8) applies if, for the period of account immediately before the relevant period, the person prepared or was required to prepare accounts in accordance with old standards, and (b) subsection (9) applies in any other case. Where this subsection applies, the Taxes Acts (other than this section) have effect as if the person prepared or was required to prepare accounts, for the relevant period and any later period of account, in accordance with those old standards. Where this subsection applies, the Taxes Acts (other than this section) have effect as if the person prepared or was required to prepare accounts, for the relevant period and any later period of account, in accordance with the corresponding old standards. For the purposes of subsection (9)— (a) if the new standards are international accounting standards, the corresponding old standards are international accounting standards disregarding any leasing change, and (b) if the new standards are UK GAAP, the corresponding old standards are UK GAAP disregarding any leasing change. In this section— “accounting body” means the International Accounting Standards Board or the Accounting Standards Board, or a successor body to either of those Boards; “accounting standard” includes any statement of practice, guidance or other similar document issued or recognised by an accounting body; “change”, in relation to a leasing accounting standard, means the issue, revocation, amendment or recognition of, or withdrawal of recognition from, the standard by an accounting body; “international accounting standards” has the same meaning as in section 1127 of CTA 2010; “new standards” means accounting standards which reflect one or more leasing changes; “old standards” means accounting standards disregarding any leasing changes; “Taxes Acts” means— (a) the Tax Acts, and (b) the Taxation of Chargeable Gains Act 1992 and all other enactments relating to capital gains tax; “UK GAAP” means UK generally accepted accounting practice as defined in section 997(2) of ITA 2007 and section 1127(2) of CTA 2010. This section has effect in relation to any period (including any period falling wholly or partly before the day on which this Act is passed) in respect of which a change to a leasing accounting standard which occurs on or after 1 January 2011 may or must be adopted by any person for accounting purposes.

(8)

(9)

(10)

(11)

(12)

FINANCE (No.3) BILL

DRAFT EXPLANATORY NOTE LEASES AND CHANGES TO ACCOUNTING STANDARDS SUMMARY 1. This clause ensures that businesses which account for lease transactions using a new form of leasing accounting standard will be treated for tax purposes as if the changes to the leasing accounting standard had not taken place. DETAILS OF THE CLAUSE 2. 3. 4. Subsection (1) provides that the clause applies to changes in a leasing accounting standard occurring on or after 1 January 2011. Subsection (2) defines what constitutes a leasing accounting standard. Subsection (3) provides that the clause will not apply to a change in a leasing accounting standard if it is a change to UK Generally Accepted Accounting Practice (UK GAAP) that permits or requires businesses to account for a lease, or a transaction accounted for as a lease, in a manner equivalent to that provided for by the International Financial Reporting Standard for Small and Medium-sized Entities issued by the International Accounting Standards Board (but ignoring any change which may be made to the leasing section of that Standard). As a consequence, should the draft Financial Reporting Standard for Medium-sized Entities proposed by the UK Accounting Standards Board on 29 October 2010 be issued and include such an equivalent lease section then this will not constitute a change in a leasing accounting standard under this clause. Subsection (4) ensures that the clause will also apply to a change in a leasing accounting standard adopted for periods of account falling wholly or partly before the change in the leasing accounting standard occurs or before the clause is enacted. This recognises the uncertainty both as to when changes to a leasing accounting standard may occur and whether persons may be permitted to adopt the changes before any mandatory start date. Subsection (5) requires that any change in a leasing accounting standard is ignored when considering whether something has been determined or done in accordance with or by reference to generally accepted accounting practice. Similarly any change in a leasing accounting standard is ignored when considering whether accounts have been prepared or not prepared in accordance with International Accounting Standards or UK GAAP.

5.

6.

FINANCE (No.3) BILL

7.

Subsection (6) provides that for the purposes of this clause the meaning of generally accepted accounting practice and related expressions usually applicable for the Tax Acts is determined by reference to subsection (5) to such practice before any leasing accounting standard change. Subsection (7) introduces the concepts of new standards and old standards (defined in subsection (11)). It applies subsection (8) or (9) as a consequence of a person first preparing accounts (or being required to prepare accounts) in accordance with new standards. Subsection (8) will apply where the person prepared accounts in accordance with old standards in the previous period of account. Subsection (9) will apply in all other cases, for example, where a new company uses a new standard in its first period of account. Subsection (8) requires a person to use their old standard for the purpose of the Taxes Act. For example, if immediately prior to using a new standard a company was using International Accounting Standards then their old leasing standard will be International Accounting Standards disregarding any changes to lease accounting standards. Subsection (9) requires a person to use the old standard that corresponds to their new standard for the purpose of the Taxes Acts. For example, if a sole trader business uses UK GAAP (incorporating changes to a leasing accounting standard) then the corresponding old standard will be UK GAAP disregarding the changes to the leasing accounting standard. Subsection (10) defines for the purposes of subsection (9) what corresponding old standards are. Subsection (11) provides relevant definitions for the purposes of this clause. Subsection (12) provides that the clause applies where there is a change to a leasing accounting standard occurring on or after 1 January 2011 and ensures that it applies to any period, including any period falling wholly or partly before the clause is enacted. This recognises the uncertainty both as to when changes to a leasing accounting standard may occur and whether persons may adopt the changes before any mandatory start date.

8.

9.

10.

11. 12. 13.

BACKGROUND NOTE

FINANCE (No.3) BILL

14.

A significant part of the corporation tax and income tax code for leases is based on accounting definitions, particularly the distinction between finance leases and operating leases, and the resulting entries in accounts prepared in accordance with either UK GAAP or International Accounting Standards. Fundamental changes to lease accounting, in particular the removal of the distinction between finance leases and operating leases, within International Accounting Standards are expected during 2011. UK GAAP may also introduce similar fundamental changes to lease accounting during 2013. If these changes go ahead as planned the current tax rules will not work as originally intended, or in some situations not work at all. This clause prescribes which version of the accounting standards a business must use when determining and computing lease entries for tax purposes in order to ensure current tax law is maintained and operates as originally intended. Businesses which account for lease transactions using a new form of leasing accounting standard will for tax purposes be treated as if the changes to the leasing accounting standard had not taken place. If you have any questions about this change or comments on the legislation, please contact Alison Bull on 020 7147 2595 (email: alison.bull@hmrc.gsi.gov.uk) or Paul Hindley on 020 7147 0429 (email: paul.hindley@hmrc.gsi.gov.uk).

15.

16.

17.