BLM50005 - IFRS 16 leases: Introduction to taxation of IFRS 16 lessees

This part of the manual only deals with payments of rent (including rent rebates received on termination). It does not consider incidental costs concerned with leasing transactions (often capital – see BLM32040) or costs concerned with the modification of the leased asset.

IFRS 16 mandatorily replaces the accounting standard IAS 17 for accounting periods beginning on or after 1 January 2019. Entities have the option to adopt the standard early if they also adopt certain other new IFRS accounting standards.

The main change in the new standard is that it removes the distinction between on-balance sheet leases (finance leases) and off-balance sheet leases (operating leases) for lessees only. IFRS 16 requires a lessee to recognise on its balance sheet all leases, except certain exempted leases.

The accounting for an IFRS 16 lessee bears a resemblance to finance lease accounting. The lessee recognises a right-of-use asset and a lease liability on its balance sheet. Over the life of the lease the right-of-use asset is depreciated. Cash rentals are set against the lease liability and the interest charge recognised on that liability. Like for a finance lease lessee, the cash rentals diverge from the depreciation and interest charge recognised on the reducing liability.

Large corporates will be the main entities adopting IFRS 16 but those entities which use FRS 101 will also have to adopt the standard. There are several different options for how a lessee adopts IFRS 16 and some of those can result in large debits being recognised in equity as a result of the timing differences between operating lease and right-of-use lease accounting.

Further background on the accounting standard is given in BLM17000 et seq

It is important to remember that commercially nothing has changed for a lessee who has adopted IFRS 16. Although the accounting timing recognition of the rentals has changed, the actual cash rentals have not and neither have the commercial reasons for entering into leases. The same basic principles remain for the taxation of a lease held by an IFRS 16 lessee, such as most rentals being on revenue account despite the on balance sheet accounting and the need to test whether the lease is a long funding lease.

Legislation was introduced in Schedule 14 FA 2019 that aimed to ensure that the new accounting standard did not change the tax treatment of lessees and required the spreading of any amounts recognised on adoption of IFRS 16. The spreading rules are explained in BLM52000