FRS 116 Leases Key Concepts Of FRS 116 And Their Tax .

FRS 116 LeasesKey Concepts of FRS 116 And Their Tax Implications05 July 2019, FridayFacilitated by:Accredited Tax Advisor (Income Tax) Mr Chai Wai Fook andMr Ronald WongFRS 116, the new accounting standard for leases, has confounded many professionals andcompanies. Sweeping changes to lessee accounting have moved leases onto lessees’ balancesheets, while income statements are affected by the front-loading of expenses.Recognising the challenges brought about by the new accounting standard, the Singapore Instituteof Accredited Tax Professionals (SIATP) organised a Tax Excellence Decoded session whereAccredited Tax Advisor (Income Tax) Chai Wai Fook, Partner, Tax Services, Ernst & Young SolutionsLLP and Ronald Wong, Partner, Financial Accounting Advisory Services, Ernst & Young LLP,highlighted key concepts of the new accounting standard and their tax implications.FRS 116 Lease Accounting ChangesThere is good news for lessors – lessoraccounting is substantially unchanged fromcurrent accounting.Lessees, on the other hand, bear the brunt ofthe changes as most leases will now berecognised on their balance sheets as a rightof-use (ROU) asset with a related lease liability.Importantly, companies will need to focus onwhether an arrangement contains a lease or aservice agreement because there aresignificant differences in the accounting.Judgement may be required in applying thedefinition of a lease to certain arrangements,particularly those that include significantservices.To assess whether a contract conveys the rightto control the use of an identified asset for aperiod of time, companies will need to assesswhether, throughout the period of use, thecustomer has both the right to obtainsubstantially all of the economic benefits fromuse of the identified asset and the right to directthe use of the identified asset. In contracts thatinclude significant services, determiningwhether the contract conveys the right to directthe use of an identified asset will requirejudgement and may pose challenges tocompanies.Both lessees and lessors will be subject RMINING IF AN ARRANGEMENTCONSTITUTES A LEASEFor an arrangement to constitute a lease underthe new FRS 116, it is critical to consider if thecontract conveys the right to control the use ofan identified asset for a period of time inexchange for consideration.Promoting Tax Excellence by SIATPAccredited Tax Advisor (Income Tax) Chai Wai Fook,Tax Services Partner, Ernst & Young Solutions LLP,sheds light on the tax treatment and implications onleases of FRS 116.Page 1

LEASE AND NON -LEASE COMPONENTSLEASE LIABILITY MEASUREMENT FORLESSEESWithin a contract, lease and non-leasecomponents are required to be accountedseparately, unless companies apply thepracticalexpedienttocombinebothcomponents. Election applies to the entire classof underlying assets. The consideration is thenallocated based on each component’s relativestandalone selling price (if the price is notreadily available, an estimate should be used bymaximising observable inputs).Identifying non-lease components of contractsmay change practice for some lessees andmore robust processes will need to be put inplace to identify the lease and non-leasecomponents of contracts.SHORT-TERMLEASES AND LOW -VALUEASSET LEASESShort-term leases and leases for which theunderlying asset is of low value may beexempted from applying a single lesseeaccounting model under FRS 116.A lease is considered short term if the term is12 months or less, without purchase options.When determining the period, extension optionsmust be factored in if it is reasonably certain thatthey would be exercised.As mentioned earlier, lessees would nowrecognise an ROU asset and a lease liability ontheir balance sheet under FRS 116.The lease liability is the present value ofremaining lease payments at commencement.“Lease payments” refer to fixed payments (andin-substance fixed payments), variable leasepayments based on an index or rate (but notthose based on performance or usage), leaseincentives and residual value guarantees.Lease payments are also required to includetermination penalties and the exercise price ofpurchase options if they are reasonably certainto be incurred or exercised.Ideally, the discount rate to be used in thepresent value calculation would be the interestrate implicit in the lease, but this could bedifficult to obtain in practice. Incrementalborrowing rate, which is the rate that the lesseewould incur in borrowing (over a similar termand with a similar security) the funds necessaryto obtain an asset of a similar value to the ROUasset in a similar economic environment, isoften used as an alternative.Leases are assessed on an asset-by-assetbasis when determining if the “low-value asset”criterion is met, but only when each asset is nothighly dependent on or interrelated with others.For example, the leasing of tyres separatelyfrom a truck may not constitute a low-valueasset lease as they can only be used with thetruck and as such, they are dependent on, orhighly interrelated with the truck. Contrast thisto the leasing of 200 laptops where each laptopcould potentially qualify as low-value assetgiven each laptop may be assessed as beingdistinct on its own. As to the definition of “lowvalue”, the International Accounting StandardsBoard has in mind a value of US 5,000 or less,based on when the asset is new.Promoting Tax Excellence by SIATPPage 2

Tax Treatment For LeasesThe Inland Revenue Authority of Singapore hasissued an e-Tax guide on 8 October 2018 toprovide guidance on the tax treatment forentities adopting FRS 116 or SFRS(I) 16.TAX TREATMENT FOR LESSORThere is no change to the existing tax treatmentfor lessors as lessor accounting has remainedsubstantially the same under FRS 116. The taxtreatment depends on the classification of thelease under section 10D of the Income Tax Act(ITA).For leases classified as operating lease for taxpurposes, the lessor is taxed on the leaseincome on an accrual basis. Capital allowanceis claimable by the lessor on the leased asset ifit qualifies as a machinery or plant. Lessors cancontinue to elect to be taxed on their leaseincome determined using the effective rentmethod under FRS 116, on the condition thatthe application of FRS 116 tax treatment ismade consistently every year and across for alloperating leases.For finance leases not treated as a saleagreement for tax purposes, the full leasepayment(bothinterestandprincipalrepayment) is taxable. Capital allowance can beclaimed on the leased asset (if it qualifies as amachinery or plant), but only against financelease income. This restriction for capitalallowance is lifted when the lessor stopscarrying on finance lease activities.For finance leases treated as a sale agreementfor tax purposes, the lessor is taxed on theinterest income on an accrual basis. Principalrepayment is not taxable. Capital allowance isnot allowed on the leased asset for the lessor.TAX TREATMENT FOR LESSEENotwithstanding the change to a single lesseeaccounting model, lessees would be allowed toclaim tax deductions based on the contractuallease payments incurred, except undercircumstances when a sale is regarded to havetaken place for tax purposes. On the other hand,interest expense and depreciation charged tothe profit or loss account would have to beadded back in the tax computation.Where a lease arrangement giving rise to anROU asset meets the statutory definition of afinance lease under Section 10D(3) of the ITAand is regarded to be a sale agreement, thelessee would be eligible to claim interestexpense and capital allowances, but not thelease payment. A lease arrangement that doesnot meet the definition of a finance lease underSection 10D(3) of the ITA will be regarded as anoperating lease.To determine whether a finance lease should beregarded for tax purposes as a sale agreement,reference should be made to the conditionslisted in paragraphs (a) to (e) of Regulation 4(1)of the Section 10D (Income from FinanceLeases) Regulations. If any of these conditionsis satisfied, then the finance lease is treated asa sale agreement.TRANSITIONAL TAX TREATMENTFor lessors, tax adjustments are generallyunnecessary since tax treatment remainsunchanged. Although intermediate lessors(under subleases) must reassess theirclassification of subleases under FRS 116, notax adjustment is required.Lessees can continue to deduct contractuallease payments for tax purposes, except wherethe lease is a finance lease regarded as a sale.Any accounting adjustments to beginningretained earnings are neither taxable nordeductible.Promoting Tax Excellence by SIATPPage 3

Sublease Arrangements Under FRS 116Notwithstanding the accounting treatment forsublease under FRS 116, for tax purposes, theclassification of a sublease for the intermediatelessor is to be determined by reference to theunderlying asset instead of the ROU asset. Thetax treatment for the intermediate lessor willdepend on the classification of the sublease fortax purposes.Accredited Tax Advisor (Income Tax) Chai Wai Fook(2nd from left) and Ronald Wong (2nd from right)answered queries about FRS 116 and its tax treatment.Withholding TaxWithholding tax obligations are based on thelegal characterisation of the payment (lease orinterest) as provided in the ITA, regardless ofthe accounting classification of the expenses inthe profit or loss account.The lessee will have to treat the entire amountof lease payments to a non-resident lessorunder an operating lease or finance lease notregarded as a sale for the use of any movableproperty as rental payment for withholding taxpurposes and withhold tax, unless specificexemption applies. On the other hand, thelessee will have to withhold tax on the interestportion of the lease payments to a non-residentlessor under a finance lease treated as a saleagreement unless specific exemption applies.As an administrative concession, tax may bewithheld based on interest expense asrecognised by the lessee (that is, computed withthe lessee’s own incremental borrowing rate).Promoting Tax Excellence by SIATPTo navigate the many changes to leaseaccounting and the resulting tax implications,taxpayers would need to pay close attention tothe differences between the accounting and taxtreatment, for example, the need torecharacterise lease payments for withholdingtax compliance. Taxpayers should also expectincreased scrutiny from the tax authorities goingforward, and start preparing documentation tosubstantiate their tax positions and leaseclassification for tax purposes.Please click here to rate this article.Page 4