The Retailer Winter 2018/19

Tax impact of IFRS 16 – are you up to speed?

EMMA THOMAS SENIOR MANAGER – CORPORATE TAX TEAM GRANT THORNTON

THE TAX IMPACT OF IFRS 16 COULD HAVE SIGNIFICANT CASH TAX AND COMMERCIAL IMPACTS – TIME TO GET UP TO SPEED As you may know, the new lease standard IFRS16 ‘Leases’ is effective for accounting periods starting on or after 1 January 2019, and represents a major change to the way leases will be accounted for. As a quick recap: There will no longer be an accounting distinction between operating and finance leases. There will be depreciation of the “right of use” asset and a finance cost on the lease liability i.e. operating lease charges which were previously recognised as part of EBITDA, will now be recorded ‘below the line’ as Retailers that have a portfolio of leased premises face a substantial information gathering exercise, not just to assess the accounting impact, but also the tax. Of course, when we say “tax” the first questions that cross your mind are probably i) is this going to create a cash tax cost? ii) is there additional work I need to do? Fortunately, the legislative changes for lessees, including those relating to property, on transition to IFRS 16 predominantly look to preserve the status quo for taxpayers, which is good news. Instead of an operating lease rental charge to P&L which is tax deductible, like a finance lease, the interest expense and depreciation charge (discussed above) will be tax deductible on the accounts basis. Very broadly, the idea is that it provides a level playing field i.e. a lessee should be left in broadly the same position whether they use UK GAAP or IFRS. So if the overall tax treatment remains broadly the same, why is tax still a concern? depreciation and finance costs. So what about the tax?

1. Transitional adjustments – on change of accounting policy there will be a “transitional” accounting adjustment, which could be significant on large property portfolios. There are choices on accounting options which may be adopted and the outcomes will need to be modelled. From a tax perspective, whilst a transitional adjustment would normally be taxed in full on the year of transition under the “change of basis” rules, new tax legislation provides that the IFRS 16 adjustment shall be “spread” across what is being referred to as the weighted average remaining life of the leases - to provide fairness and reduce volatility. As you can imagine this will require a good amount of information gathering on the lease portfolio and detailed calculations to ensure compliance with tax law, and to prevent unnecessary cash tax leakage. Further, where the amounts arising for accounts purposes are not fully taxed in the period, but in a later period (i.e. there is a timing difference between the tax and accounting), this “deferred tax” impact needs to also be thought about 2. Corporate interest restriction (“CIR”) rules – these rules in themselves are new and highly complex, and not covered in this article. Very broadly, the rules look to restrict interest, or interest like expenses, in groups of companies where the net interest exceeds £2 million on an annual basis. Albeit interest costs arising on finance lease costs are brought into these rules, new tax legislation specifically looks to retain the distinction between operating and finance leases for tax purposes. Essentially there is a carve out for interest arising on leases that would for tax purposes be treated as operating leases. As well as understanding the rules, there will be additional practical considerations, for example, separate ledger accounts splitting interest on operating and finance lease identified for tax purposes so amounts can be tracked. This is a complex area and specialist advice is recommended. for financial reporting, and corporation tax filings. Additional complications can arise where consolidated accounts for group reporting are under IFRS, and local company accounts are under UK GAAP. Quite a bit of extra work for starters!

26 | winter 2019 | the retailer