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HMRC internal manual

Corporate Finance Manual

Interest restriction: leasing: IFRS 16 examples

Example 1 – Operating Lease

A Ltd prepares financial accounts under IAS.  It rents property for use in its trade and classifies  the property lease as an operating lease under IAS 17.  From 1 January 2019, A Ltd adopts IFRS 16.

CIR treatment:

For the yearended 31 December 2018, A Ltd classifies the lease as an operating lease and includes the lease costs as rental payments in its income statement.   For CIR, because this is an operating lease, no amount is included as a tax-interest expense. 

For the year ended 31 December 2019, A Ltd accounts for the lease as a right-of-use lease.  A Ltd will now recognise two amounts in its income statement – a depreciation charge and a finance charge on the lease liability.  The new CIR rules require A Ltd to consider whether the lease would be an operating lease or a finance lease, as if it had used an accounting standard that required it to differentiate between the two.  Because the lease would have been classed as an operating lease under FRS 102, neither the depreciation nor the finance charge is included as a tax-interest expense for CIR.

Since the lease had already been previously classified as an operating lease, unless the terms of the lease changes, A Ltd need not carry out an actual accounting classification test in the year ended 31 December 2019; A Ltd can simply continue to classify the lease as an operating lease for CIR purposes.

Example 2 – Finance Lease

B Ltd prepares financial accounts under IAS.  It leases machinery for use in its trade and accounts for this as a finance lease under IAS 17.  From 1 January 2019, B Ltd adopts IFRS 16.  Under IFRS 16, the measurement methodology of the finance charge is different from that under IAS 17.

CIR treatment:

For the year ended 31 December 2018, B Ltd classifies the lease as a finance lease.  The machinery is shown as an asset on the balance sheet and the income statement includes debits of £200k for depreciation and £300k as the finance charge.  For CIR, because this is a finance lease, the £300k finance charge is included as a tax-interest expense (TIOPA10/S382).

For the year ended 31 December 2019, B Ltd accounts for the lease as a right-of-use lease.  The machinery is shown as an asset on the balance sheet and the income statement includes debits of £250k for depreciation and £200k as the finance charge.  The new CIR rules require B Ltd to consider whether the lease would be an operating lease or a finance lease, as if it had used an accounting standard that required it to differentiate between the two.  Because the lease would have been classed as a finance lease under FRS 102, the £200k finance charge is included as a tax-interest expense. 

It does not matter that the measurement under FRS 102 (or any other standard) would have been different, the classification only acts to determine whether or not the actual finance charge element calculated under the current accounting standard should be included in tax-interest for CIR purposes.

Example 3 - Exception

C Ltd prepares financial accounts under IAS.  It leases IT equipment for use in its trade and accounts for this as a finance lease under IAS 17.  From 1 January 2019, C Ltd adopts IFRS 16.  Under IFRS 16, C Ltd elects that the lease be treated as a lease of low-value assets.

For the year ended 31 December 2018, C Ltd accounts for the lease as a finance lease.  The IT equipment is shown as an asset on the balance sheet and the income statement includes debits of £200k for depreciation and £300k as the finance charge.  For CIR, because this is a finance lease, the £300k finance charge is included as a tax-interest expense (TIOPA10/S382).

For the year ended 31 December 2019, C Ltd has elected that the lease for the IT equipment is a lease of low-value assets.  It does not include the IT equipment on its balance sheet, and the income statement includes a debit of £300k for rents payable (and no finance charge).  For CIR purposes, because the exemption applies and the lease is not a right of-use-lease under IFRS 16, there is no need to apply the classification test.  There is no finance charge in the income statement that can be included as a tax-interest expense.