A lease and a hire purchase contract have similar features except that, under a hire purchase contract the hirer may acquire legal title to the asset by exercising an option to purchase the asset whereas there is normally no provision in a lease contract for legal title to pass to the lessee.
There are two main types of lease contract, finance lease and operating lease.
A finance lease is a method of providing finance. In legal form a finance lease is just another lease, the legal ownership of the asset remaining with the lessor. However, the economic ownership of the asset, (the risks and rewards of ownership) lies with the lessee. In substance, the finance lessee buys the asset with a loan from the lessor.
The special character of a finance lease lies in the way the rentals are calculated. In economic substance a finance lease is a loan of money with the asset as security:
- the lessor provides the money for the lessee to buy an asset in return for an interest charge
- the lessor has security because it owns the asset
- the leasing arrangement aims to give the lessor a banker’s interest turn and no more or less.
An operating lease is any lease that is not a finance lease and is often akin to the hire of an asset. The terms of an operating lease do not guarantee that the lessor will get back all, or substantially all, of the cost of the asset plus a commercial rate of interest. The lessor therefore has an equity interest in the leased asset and has most or all of the risks and rewards of ownership.
How to deal with leases in accounts
Historically, leases were treated in the accounts of a business in accordance with Statement of Accounting Practice (SSAP) 21. This was superseded for accounting periods commencing on or after 1 January 2015 and the current standard (International Financial Reporting Standard (IFRS) 16) is operative for accounting periods commencing on or after 1 January 2019.
It is not intended that the effective Jersey tax treatment of leases be amended following the transition to the new standard such that leases with the same terms will be taxed in the same way regardless of the accounting framework the lessee has adopted.
The taxation treatment in Jersey should be as follows:
Broadly speaking the lease rental payments and interest element of the lease are allowable to the trader. Depending on how the finance lease has been treated in the accounts such adjustments should be made in the computation to deliver this outcome.
The lessee cannot claim capital allowances on the leased asset as it does not belong to them. The lessor, on the other hand, can (provided the asset qualifies as plant and machinery).
The rental payments in respect of an operating lease are an allowable deduction. Similar to the position for finance leases above, adjustments to achieve this outcome should be made in the tax computation.
Hire purchase contracts
Goods bought on hire purchase are deemed to belong to the hirer and not the hire purchase company. Assets acquired through hire purchase will therefore be due capital allowances.
Tax implications specific to the implementation of IFRS 16
IFRS 16 requires a single model approach for lessees. Almost all leases are now brought on to the balance sheet with a right-of-use asset and financial liability being created. The lease liability is recognised at the present value of future lease payments and the value of the right-of-use asset the value of which is adjusted for the initial direct costs and any restoration costs.
In regard to the first time application of IFRS 16 the right-of-use asset will be recognised for assets that were previously leased by the trader and accounted for as operating leases. The accounting treatment will recognise depreciation of the asset and the interest element of the lease payments.
Under IFRS 16 there are transitional adjustments that may be reflected in the 2018 or 2019 financial statements.
Full retrospective approach
Under this approach the company would restate the position of the prior year comparatives. The adjustment is recognised through the opening balance of the equity accounts of the company for the 2019 financial year. As this transitional adjustment has no impact on the profit and loss account there are no tax implications where this approach is adopted.
Modified retrospective approach
This approach does not result in a restatement of the prior year financial position and the standard is applied from the beginning of the current financial period and reflected through the retained earnings. As the treatment of lease payments in Jersey in accordance with this guidance does not alter pre and post implementation of IFRS 16 no further relief in respect of this adjustment will be due to the trader post adoption in respect of this transitional adjustment.