chartered accountant
The Ministry of Corporate Affairs (MCA) announced a notification implementing Ind-AS 116 ‘Leases’ effective from April 1, 2019. This regulation supersedes Ind AS 17 and AS 19. Previously, entities governed by Ind AS followed Ind AS 17 for leased assets, while those exempt from Ind AS adhered to AS 19. Under both standards, lease agreements were classified as either operating leases or finance leases, which are defined as follows:
Operating Lease: In this arrangement, the lessor maintains legal ownership of the asset, allowing the lessee to utilize the asset for a predetermined period in return for lease payments.
Finance Lease: A finance lease encompasses leasing the asset for its entire useful life or transferring ownership to the lessee at the lease term's conclusion for a nominal fee.
Ind AS 116 abolishes the distinction between these lease types for lessees.
Understanding the key provisions of Ind AS 116 is crucial before examining its tax implications. This standard applies to all lease arrangements, except low-value and short-term leases. Noteworthy is its treatment of leases from the lessee's perspective, which now involves a consistent accounting method irrespective of lease classification.
Upon lease commencement, the lessee must recognize a 'Right to Use' asset along with a corresponding lease liability calculated at the net present value of future lease payments. The 'Right to Use' asset is depreciated over the lease term, while finance costs are computed on the outstanding lease liability. Lease payments progressively reduce this liability.
Under Ind AS 116, both depreciation and finance costs appear on the Profit and Loss Account (P&L), replacing the previous practice of recording lease rental payments on a straight-line basis. Notably, the total depreciation and finance costs recognized over the lease term align with the total lease rental payments, meaning the transition to Ind AS 116 does not create an overstatement or understatement of the P&L; instead, it alters expense recognition without altering total expense over time.
It is essential to recognize that the taxability of lease transactions is based on their economic substance and legal form, rather than their accounting treatment. Thus, while Ind AS 116 significantly modifies one’s accounting approach to lease transactions from the lessee's viewpoint, the tax treatment remains consistent.
With the adoption of Ind AS 116, the recognition of notional depreciation and finance costs occurs, while previously considered lease rent payments are now accounted for as deductions from the lease liability rather than as P&L expenses.
Therefore, it can be suggested that, since finance costs and depreciation are notional, these should be added back in tax calculations, while actual rental payments can be deducted.
Paragraph 102A: Seller-lessees are now required to incorporate variable lease payments into lease liability measurements. The rules preceding 2024 lacked explicit guidance on including these payments.
Gain/Loss Recognition: The new rules prohibit recognizing gains or losses on portions of the asset retained by the seller-lessee. Previous guidance permitted partial gain recognition in sale-leaseback transactions, which is now refuted under Paragraph 102A.