Tax Talk | Alignment of tax treatment of non-property leases with NZ IFRS 16

In order to reduce compliance costs, government is proposing to allow taxpayers to more closely follow their accounting treatment when it comes to certain leases and therefore proposes to amend the Income Tax Act 2007 effective from 1 January 2019.

How the amendment will work

Tax law will be amended to allow taxpayers to apply NZ IFRS 16 for tax purposes for all operating leases of personal property that meet the following criteria:

• The person applies NZ IFRS 16 for accounting and chooses to apply NZ IFRS 16 for tax;
• The lessor and lessee are not associated; and
• The asset is not subleased to another person

Taxpayers will be able to elect to apply NZ IFRS 16 for tax purposes, otherwise the standard tax approach will continue to apply. Some of the key elements are discussed below: 

Real property

Leases of real property (i.e. land and buildings) will continue to be treated as operating leases for income tax purposes. Therefore, where real property is leased, tax adjustments and the necessary calculations will still be required.

Associated parties

The differing treatment between lessors and lessees can give rise to a tax timing advantage compared with direct purchase. Therefore, to prevent this scenario, the amendment will require leases of all property between associated parties to continue the existing approach.

Subleases

Under NZ IFRS 16, when an asset is subleased to a second person, and the sublease of the lessor is a finance lease for accounting, the asset changes from a right-of-use asset to a finance lease receivable. The result from a tax perspective is that the lessor would not be entitled to a deduction for the amortisation of the right-of-use asset. Therefore, the amendment will require subleases of all property to continue separate tax and accounting treatment.

Election

Lessees who use NZ IFRS 16 will be able to elect to apply NZ IFRS 16 for tax. This election will be made by calculating deductions based on NZ IFRS 16 and no separate document would need to be filed with Inland Revenue. Once an election had been made, lessees will need to continue using this method while they apply NZ IFRS 16 for accounting purposes.

If a taxpayer chooses to apply standard tax rules, they will continue to have the ability to elect to apply NZ IFRS 16 for tax purposes in a future year.

Calculations

The broad principle is that over the lifetime of the lease, the deduction available to taxpayers will be same regardless of whether they follow standard tax rules or follow NZ IFRS 16. As a result, wash up calculations will be required in several scenarios including:

• Lease maturity
• The lessee and lessor become associated
• The asset is subleased to another person
• The lessee stops following NZ IFRS 16 for accounting

Comment

The planned amendments follow a trend by government over the last twenty years to have tax follow accounting standards where it is practical to do so. This should enable a saving in compliance costs for some businesses who apply NZ IFRS.

Unfortunately for businesses who lease real property, complex calculations will be necessary to correctly account for tax. We expect most businesses will be subject to this issue as leases of land and buildings is the most common IFRS 16 adjustment and the reality is that this measure is unlikely to provide much real benefit.