International Finan-cial Reporting Standards 16 - IFRS 16 - on lease has now been issued to take effect after January 1, 2019.
IFRS's are issued by the International Accounting Standards Board as rules of accounting to be followed by accountants. However, they do not necessarily affect tax treatment.
The hiring and leasing of all kinds enjoyed a boom in the 1990s as it lends itself to various schemes for avoiding or reducing tax charges, and this did not escape the notice of the leasing industry. Businesses were readily persuaded that considerable taxation and financial advantages might be gained from leasing rather than acquiring ownership of an asset.
For most types of assets of material value, the person aspiring to have the use of it is offered the choice of permanent ownership or temporary possession - similar to renting a house instead of home purchase.
Likewise, the alternative to purchasing an asset, such as a car, is to lease it for a period. A rental period is usually offered, where a lump sum is paid in advance followed by equal monthly instalments. The hire agreement will sometimes include maintenance, attracting considerably higher monthly rental payments.
The most popular form of leasing is 'contract hire' where the lessor - the person who owns and leases the asset - takes responsibility for all repairs and maintenance. This means that the lessee - the person who is using the asset - is freed from the worry of unexpected repair and maintenance. There will be no option to acquire the asset at the end of the hire period. This is sometimes called an operating lease. GCT is chargeable on the rental payments which are normally recovered as input tax. The lease payments are also allowable deductions for income tax.
The simplest means of obtaining actual ownership of an asset is by outright purchase, either out of funds immediately available or out of borrowed money. If done by hire purchase, for taxation the asset is treated as if it were purchased and being paid for by instalments.
If done under a 'finance lease', the agreement is structured in a way that will ensure that during the period of the lease the lessor's continued ownership is secured. He takes no responsibility for maintaining the asset and the lessee may be given an option to acquire it at the end of the lease.
In the lease payment, there will be an element of the capital cost of the asset and an element in the instalments, which does not represent part of the capital and is usually referred to as 'interest'. However, for general consumption tax, it is not considered true interest and the full lease payment will attract GCT. Likewise, for income tax, the full payment is an allowable deduction.
These, in a nutshell, are the factors on taxation to be considered in a choice between outright purchase and contract hire. But we must travel along the Yellow Brick Road to the Emerald City in search of the wizard, for instructions on IFRS 16. The standard setters appeared to have hired Mandrake the Magician - conjuring up the basic tenets of this standard.
IFRS 16 contemplates that all lease with a term greater than a year should be placed on the balance sheet as if owned by the lessee. But this is not just an academic exercise, it brings to bear the principle of 'substance over form'. That is to say, the financial statements is showing 'the overall financial reality of the entity (economic substance) rather than the legal form of transactions (form)'. In this case, the lessee is treated as really acquiring the asset and financing its acquisition.
Perhaps the motivation is to keep certain liabilities off the balance sheet, but the business substance outweighs this effort of 'form', and must reflect the 'substance' in economic terms.
In this case, the legal form is the mortar, not the bricks, of the transaction. Therefore, the lessee will be treated as owning the asset even though the title was not legally transferred to him.
Notwithstanding, for taxation, the legal form will prevail, unless it can be shown that there is an avoidance scheme at work and the law clearly has an anti-avoidance provision that would counteract such a scheme.
Everald Dewar is senior taxation manager at BDO Chartered Accountants in Kingston. Email: everald.dewar@bdo.com.jm [2]