HMRC consults on corporate interest restrictions and IFRS 16 Leases

A consultation has been launched by HMRC on corporate interest restrictions in order to take account of the accounting changes brought about by IFRS 16 Leases

IFRS 16, which was issued in January 2016 and applies from 1 January 2019, requires companies with lease arrangements to bring them onto the balance sheet, with around $1 trillion (£741bn) of assets affected.

The 23-page consultation makes clear that where a lease is essentially a form of financing, the government’s intention is to recognise that. Therefore, within the corporate interest restriction rules, the finance cost or finance income element of the rental payments under such a lease should be recognised as tax-interest.

Companies and groups with net financing costs of more than £2m per annum, who also lease assets for use in their business; lessors; agents and representative bodies are all affected.

The current corporate interest restriction rules use as its starting point the accounting classification of leases into operating leases and finance leases. But IFRS 16 will not classify leases in that way for lessees. As such, the consultation will explore three options for amending the CIR rules to accommodate IFRS 16.

The first option is described as ‘following the accounting’, where the accounting standard/framework adopted by the lessee or lessor recognises a finance amount in respect of a lease, that amount would also be recognised as tax-interest within the corporate interest restriction rules. Where no finance amount is recognised for accounting purposes, there would be no tax-interest pick up for corporate interest restriction purposes.

This treatment would apply regardless of whether IAS or one of the UK GAAP frameworks is adopted. If the treatment of leases in the accounts is not in accordance with GAAP, an appropriate GAAP-compliant4 treatment would be assumed to apply for corporate interest restriction purposes.

The second option is to keep a distinction between operating leases and finance leases for corporate interest restriction purposes. Under this option, tax interest would include amounts where a lessee recognises a finance charge in relation to a leased asset. However, that finance charge would not need to be included in tax-interest under the corporate interest restriction rules where the lessor prepares GAAP-compliant accounts which do not recognise the equivalent finance income in relation to that leased asset.

The third and final option is to introduce a distinction between funding leases and non-funding leases, to be defined in tax legislation for corporate interest restriction purposes.

This option would see the accounting classification of a lease ignored, but the tax-interest amount for corporate interest restriction purposes would still be based on the accounting measurement of the finance charge amount in accordance with GAAP.

Instead of applying accounting classification rules, a company would apply tax rules in order to classify a lease.

The 23-page consultation runs until 28 February 2018 and is available here.

Report by Calum Fuller

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