Deferred Tax implications – Related to Ind AS-116

Background, Ind AS-116 Leases brings significant changes in accounting requirements for lease accounting, mainly for lessees. The new standard replaces the existing standard i.e. Ind AS-17, Leases with effect from accounting periods beginning on or after 1 April 2019. The new standard requires lessees to recognise “Right-of-use assets” and “Lease Liability” in balance sheet and depreciation and finance cost in Statement of profit & loss. For tax purposes, lease rentals are allowed as deduction while computing taxable income. The dissimilarity in treatment between Ind AS and taxation gives rise to deferred tax.

Deferred tax treatment:-

The lessee, recognise right-of-use assets and depreciate the same. The depreciation on right-of-use asset and finance cost will not be deductible for tax purposes. There is a timing difference in terms of the accounting profit and the taxable profit.

As per Ind AS-12 Income Taxes, The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity, therefore, the tax base of right-of-use asset is zero. When the carrying amount of the asset exceeds its tax base, this difference is a taxable temporary difference and the obligation to pay the resulting income taxes in future periods is a deferred tax liability (DTL).

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In case of lease liability, the lessee will get the deduction of the lease rentals. Therefore, the tax base of lease liability will also be zero. If the carrying amount of a liability is more than its tax base, the difference gives rise to deferred tax asset (DTA).

Further Ind AS-12 Income Taxes, provides an entity to set off a deferred tax asset against a deferred tax liability of the same taxable entity if, and only if, they relate to income taxes levied by the same taxation authority and the entity has a legally enforceable right to set off. Hence an entity can recognise DTA/DTL as the case may be, to the extent of difference between right-of-use asset and lease liability.

Example:-

Company X Ltd. enters into a lease with a lease term of 15 years, with yearly lease payments of Rs.10,000 paid in arrears. The incremental rate of borrowing is 10%. There are no initial direct costs to obtain the lease. The applicable income tax rate is 25%. Lease rentals are permissible for deduction. Depreciation of the right-of-use asset and finance expenses on the lease liability are both non-deductible. Calculate DTA/DTL at the end of year one?

Answer:-

At the commencement of the lease, the lease liability and right-of-use asset are both recognised at Rs. 76,061. As at the end of the first year of the lease, the carrying value of the right-of-use asset is Rs. 70,990 and the lease liability is Rs. 73,667. The right-of-use asset gives rise to a deferred tax liability of Rs. 17,748 (Carrying value Rs.70,990- zero tax base) and the lease liability gives rise to a deferred tax asset of Rs. 18,417 (Carrying value Rs. 73,667 – zero tax base). The net deferred tax asset of Rs. 669 (Rs.18,417 – Rs. 17,748) would be presented in the financial statement.