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HMRC internal manual

Business Leasing Manual

Lease accounting: accounting standards: SIC 27, evaluating the substance of transactions involving the legal form of a lease

IFRS recognises that issues may arise where an entity enters into a transaction or a series of structured transactions (an arrangement) with an unrelated party or parties that involves the legal form of a lease. For example, an entity may lease assets to a third party and lease the same assets back, or alternatively, legally sell assets and lease the same assets back. The form of each arrangement and its terms and conditions can vary significantly. In the lease and leaseback example, it may be that the arrangement is designed to achieve a tax advantage for the third party that is shared with the entity in the form of a fee, and not to convey the right to use an asset.

SIC 27 requires that where a series of transactions that involve the legal form of a lease is linked they must be accounted for as one transaction when the overall economic effect cannot be understood without reference to the series of transactions as a whole. This is the case, for example, when the series of transactions are closely interrelated, negotiated as a single transaction, and take place concurrently or in a continuous sequence.

Extreme examples of arrangements that do not in substance convey the right to use an asset and are therefore not accounted for as leases are given in Appendix A to SIC 27. They include

  • lease and leasebacks designed to generate tax benefits for the third party with the entity (ie not the third party) retaining the risks and rewards of ownership and receiving what amounts to a fee for its involvement. Such arrangements should be accounted for as if the entity has received a fee rather than as a lease and leaseback
  • a sale and leaseback where the lessor is obligated to put the asset back to the lessee at the end of the lease period such that practical effect is that the lessor receives say a yield of LIBOR plus 2% on the purchase price.

Clearly, as these are extreme examples, this is by no means an exhaustive list.

This is a complex area of accounting standards but could be important, particularly where arrangements are entered into with a view to gaining a tax advantage and the leases have little commercial effect as leases (that is the making of assets available) and are simply the means to another end.

Seek advice from your local advisory accountant if you think SIC 27 is or might be relevant.