Introduction

MCA vide notification dated 30-03-2019, has notified Ind-AS 116 ‘Leases’ w.e.f 01-04-2019 replacing the erstwhile Ind AS 17 and AS – 19. Prior to 01-04-2019, the accounting treatment of assets taken on lease was done in accordance with Ind AS 17 and AS – 19 [for entities on which Ind AS was not applicable]. In both the erstwhile standards, lease arrangement was classified into operating lease and finance lease which are as follows:-

  • Operating Lease:- In the case of operating lease, the legal rights of the asset is retained with the lessor and lessee is allowed to use the asset for a particular time period against payment of lease rentals.
  • Finance Lease:- It is an arrangement wherein the asset is given on lease for its entire life or the ownership of the asset is transferred to lessee at the end of lease tenure for minimal consideration.

However, Ind AS 116 has done away with the aforesaid classification of lease arrangement for the purpose of lessee.

Overview of Ind AS – 116

Before moving on to the tax implications of Ind AS -116, it is important to have a brief understanding of Ind AS-116. The accounting treatment of all lease arrangements except low value leases and short term leases have to be done in accordance with the newly inserted Ind AS 116. Further, it doesn’t envisages lease arrangement into financial lease or operating lease for the purpose of lessee. Hence, the accounting treatment of lease arrangement shall be same in the books of lessee irrespective of the fact that whether the lease is finance lease or operating lease. However, there is no change in the accounting treatment of lease arrangement in the books of lessor.

As per Ind AS-116, at the commencement of lease, lessee is required to recognise ‘Right to Use’ asset and a corresponding lease liability at the net present value of all future lease payments. Further, depreciation is charged on ‘Right to Use’ asset over the term of lease and finance cost is charged on the outstanding amount of lease liability. Also, payment of lease rentals is reduced from the lease liability.

Therefore, as per the new Ind AS depreciation and finance cost is charged to P&L instead of lease rental payments [since it is reduced from liability] whereas as per the erstwhile accounting standard lease rental payment was charged to P&L on straight line basis. Further, it needs to be noted that the total amount of finance cost and depreciation charged to P&L over the entire lease term shall be equal to the total amount of lease rentals. Hence, it may be said that due to introduction of Ind AS-116, there is no overstatement or understatement of P&L but it is only a deferment of expenditure due to change in presentation and method of accounting.

The same can be illustrated through an example which are as follows:-

Suppose an asset is taken on lease for a period of ten years against an annual lease rental of Rs. 1,00,000/-. Assuming discounted rate is 7% following shall be the accounting treatment at the books of lessee.

At the commencement of lease, Right to use asset is recorded with corresponding Lease Liability at the net present value of all future lease payments discounted @ 7% i.e. Rs. 7,02,358/-.

Year
Assets
Liability
Total amount charged in P&L
[B+E]
Asset value
[A]
Depreciation
[B]
Closing WDV
[C=A-B]
Lease Liability
[D]
Finance Cost
[E]
Rental Payment
[F]
Closing Liability
[D+E-F]
1
7,02,358
70,236
6,32,122
7,02,358
49,165
1,00,000
6,51,523
1,19,401
2
6,32,122
70,236
5,61,886
6,51,523
45,607
1,00,000
5,97,130
1,15,842
3
5,61,886
70,236
4,91,651
5,97,130
41,799
1,00,000
5,38,929
1,12,035
4
4,91,651
70,236
4,21,415
5,38,929
37,725
1,00,000
4,76,654
1,07,961
5
4,21,415
70,236
3,51,179
4,76,654
33,366
1,00,000
4,10,020
1,03,602
6
3,51,179
70,236
2,80,943
4,10,020
28,701
1,00,000
3,38,721
98,937
7
2,80,943
70,236
2,10,707
3,38,721
23,710
1,00,000
2,62,432
93,946
8
2,10,707
70,236
1,40,472
2,62,432
18,370
1,00,000
1,80,802
88,606
9
1,40,472
70,236
70,236
1,80,802
12,656
1,00,000
93,458
82,892
10
70,236
70,236
93,458
6,542
1,00,000
76,778
Total
7,02,360
 
2,97,642
10,00,000
 
10,00,000

Thereafter, depreciation shall be charged on the ‘Right to Use Asset’ over the entire lease term as per the depreciation policy of the entity [assuming straight line basis in the instant case] and finance cost is charged on the outstanding  lease liability at the rate of 7%. The same can be tabulated as follows:-

From the above, it may be seen that that the total amount charged to P&L over the entire lease terms is Rs. 10,00,000/- [aggregate of depreciation and finance cost] whereas the total rental payment over the entire lease term is also Rs. 10,00,000/-.

Tax Implications of Ind AS – 116

It is a well known principal that taxability of a transaction is not driven by its accounting treatment but by its substance and legal form. Although, there is a substantial change in the accounting treatment of lease transactions from the point of view of lessee but there is no change in the tax treatment.

From the above discussion it may be noted that due to implementation of Ind AS – 116, depreciation and finance cost is charged in the P&L which is notional in nature. Besides, that payment of lease rent which was an expenses as per erstwhile Ind AS is now reduced from lease liability and not charged to P&L A/c.

Therefore, a view may be taken that since finance cost and depreciation is notional in nature therefore it should be added back in the computation whereas the periodic rental payment which is an actual expenditure should be reduced from the computation.

As a result, the tax implications of the aforesaid transactions shall be as follows:-

Year Depreciation
[A]
Finance Cost
[B]
Total Disallowance
[C]
Rental Payment
[D]
Net Disallowance
[C-D]
1 70,236 49,165 1,19,401 1,00,000 19,401
2 70,236 45,607 1,15,842 1,00,000 15,842
3 70,236 41,799 1,12,035 1,00,000 12,035
4 70,236 37,725 1,07,961 1,00,000 7,961
5 70,236 33,366 1,03,602 1,00,000 3,602
6 70,236 28,701 98,937 1,00,000 -1,063
7 70,236 23,710 93,946 1,00,000 -6,054
8 70,236 18,370 88,606 1,00,000 -11,394
9 70,236 12,656 82,892 1,00,000 -17,108
10 70,236 6,542 76,778 1,00,000 -23,222
Total 7,02,358 2,97,642 10,00,000 10,00,000

From the above table it may be inferred that although the total expenditure remains the same i.e. Rs. 10,00,000, however due to the method of accounting there is deferment of expenditure as a result of which there is net disallowance in first 5 years and net claim in next 5 years. However, the total amount disallowed shall be equal to the amount claimed over the tenure of lease. Hence, the net impact is Nil.

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