The International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) have published a joint discussion paper entitled Leases: Preliminary Views, seeking public comments on the proposed new lease accounting standards. The consultation paper can be accessed here.
Currently, the accounting treatment of finance and operating leases is different. In a finance lease, the asset must be included in the lessee’s balance sheet and the capitalised value of the lease rents shown as a liability. In an operating lease, the lease liabilities can be kept “off balance sheet” for the lessee, as the lessor would record the asset in its balance sheet and the lessee would include the rent payable in its profit and loss account.
The Boards propose that lease accounting should be based on the principle that all leases give rise to liabilities for future rental payments and assets (the right to use the leased asset). On this basis, the broad proposition is that the present value of lease rentals under the lease would be recognised as both an asset and a liability on the lessee’s balance sheet, regardless of whether that lease is an operating lease or a finance lease. A consequence of this would be to remove the distinction between finance leases and operating leases as far as a lessee is concerned. This article does not comment on the wider accounting implications of the proposals (although lessees would be advised to consider the accounting implications of the proposal within the consultation period which expires on 17 July 2009), but focuses on some of the possible implications for the tax position of a UK airline lessee.
Since the introduction of the long funding lease rules in 2006, the UK tax position of a leasing transaction depends to a large extent on the accounting treatment of the lease. In particular, one of the tests used to determine whether a lease is a long funding lease is whether it is accounted for as a finance lease. Generally, in the case of a long funding lease of an aircraft, the airline lessee is entitled to claim capital allowances (tax depreciation) in respect of the aircraft. If the lease is not a long funding lease, the lessor may be entitled to claim the allowances and the lessee is entitled to tax deductions for its lease rentals only. As a result of the new accounting practices being proposed by the IASB, an airline may, as a result of the operation of existing UK tax law but through no fault of its own, find that a lease ceases to be a long funding lease because of the change of accounting classification. This in turn would mean that the airline would no longer be able to claim capital allowances. It is understood that there are currently no proposals to change the classification of leases as far as lessors are concerned.
If the proposed changes to accounting rules are implemented, there could therefore be potential adverse tax consequences for UK airlines currently claiming capital allowances under long funding leases. Ideally, this would be rectified by recognising in the UK tax legislation that the change in accounting standards should not affect the treatment of existing leases. This issue shows the danger of HMRC’s increased focus on a company’s accounting treatment in determining its tax treatment, particularly where the control of those accounting standards is increasingly in the hands of an international body that has no real regard for the various domestic tax systems.
Although the consultation period for the accounting standard proposals is relatively short, it is not anticipated that the proposals will come into force until 2011, which should leave HMRC sufficient time to ensure that the UK tax rules are altered to ensure the change does not prejudice those companies that account under IFRS.