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Financial and Tax Accounting for Leases & Sales Tax Implications of Leases

March 2011

Acknowledgements

Canadian Lease Education Online originated from an education program developed by the United Association of Equipment Leasing (UAEL) in the United States. This session was adapted for the Canadian marketplace by Mike Stewart and Archana Jayakumar of KPMG and Jason Cooper of PricewaterhouseCoopers with the assistance of Murray Derraugh and Hugh Swandel of Swandel & Associates

2©Canadian Finance & Leasing Association

Copyright Material

© The material used in this presentation is the property of the Canadian Finance &

Leasing Association (CFLA). This material may not be reproduced or used in any other manner without the expressed

written permission of the CFLA.

Disclaimer

• The purpose of this presentation is to introduce some fundamental Canadian taxation and accounting concepts to individuals in the leasing industry

• The information contained herein is accordingly general in nature and based on authorities that are subject to change

• Applicability to specific situations is to be determined through consultation with your professional advisors

March 2011 ©Canadian Finance & Leasing Association 4

March 2011

Session Outline

Lease classificationand accounting

Canadian GAAP

IFRS vs. Private Enterprise

GAAP

Lease accountingIFRS changes

Tax Treatment for

Leases

Sales TaxImplications


March 2011

Lease Classification

• Capital vs. Operating leaseLook at whether the benefits and risks of ownership are transferred

• Under GAAP, “a lease that transfers substantially all of the risks and rewards of ownership of property should be capitalized”


March 2011

Lease Classification -Lessee

Reasonable assurance that the Lessee will obtain ownership of the leased asset by end of term

Lessee will receive substantially all of the economic benefits from use of the leased asset– Usually 75% or more

Lessor is assured of recovering investment in leased asset and of earning a return– Usually 90% or more of Fair Market Value


Lease Classification -Lessor

At least 1 of the 3 conditions from previous slide

And 2 additional criteria must be met by Lessor:

Credit risk associated with the lease must be normal compared to risk of similar receivables

Amount of any unreimbursable costs likely to be incurred by Lessor can be reasonably estimated

March 2011 ©Canadian Finance & Leasing Association 8

March 2011

Lessor Financial Statement

Amount due to Lessor recorded as a Lease Receivable

Amount of Finance Income (unearned interest) is deferred and amortized over term of lease

A portion of unearned interest is taken into income at the start of lease to offset initial direct costs, which are expensed as incurred• Credit adjudication costs• PPSA registration costs• Processing and set up of lease


March 2011

Lessor Financial Statement

Investment in the lease is recorded at:

a) The minimum lease payments receivable less any executory costs and related profit

b) Plus, any unguaranteed residual value of the leased asset accruing to the Lessor

c) Less, unearned finance income remaining to be allocated to income over the lease term


March 2011

Lessor Financial StatementDisclosure

• Net investment in leases, separated by Current and Long-term portions

• The Aggregate of the following for each of the succeeding 5 years• Future minimum lease payments receivable• Unearned finance income• Unguaranteed residual value• Executory costs included in min. lease payments• Contingent Rentals taken into income• Lease term


March 2011

Lessee Financial StatementOperating Lease

• Lease payments are expensed on a straight-line basis

• Disclose minimum lease payments for next 5 years

• Basis of determination of any contingent rentals, type of property leased, remaining term, renewal options and guarantees of residual values


March 2011

Lessee Financial StatementCapital Lease

The lease is recorded as an acquisition of an asset (leased property)

Liability is recorded for the related rental payments (Current & Long-term)

Lease is recorded at the lower of the:• Fair Market Value of the asset• Present Value of the minimum lease payments


March 2011

Lessee Financial StatementCapital Lease

Asset is amortized over the period of its expected use

Period of amortization is lease term, unless there is a bargain purchase option, in which case amortperiod should be the asset’s economic life

Lease payments should be allocated between:• Interest expense, and• Reduction of lease obligation


March 2011

Lessee Financial StatementDisclosure – Capital Lease

• Gross amount of assets under capital leases and accumulated amortization

• Major categories of leased property and accumulated amortization

• Methods and rates of amortization

• Interest rates and expiry dates of leased assets

• Terms of renewal or purchase options

• Future minimum lease payments in aggregate and for each of the five succeeding years


March 2011

IFRS vs. Private Enterprise GAAP

• Transition date of January 1, 2010

• Publicly accountable enterprise = IFRS

• All others = Private Enterprise GAAP or IFRS


March 2011

Canadian GAAP vs. IFRS

• Identification of leases

• Lease classification

• Measurement


March 2011

Changes in IFRS

• Complex changes to the current model are proposed

• Exposure draft issued in Q4 2010

• FASB and IASB converge on revised lease accounting standard to replace IAS 17

• Final standard expected by June 2011

• Transition date has not been determined


The “right-of-use” model

Lessor Lessee

Recognise “right-of-use”

asset

Recognise liability to pay

rentals

Right to use leased asset

Consideration(lease rentals)

Performance obligation approach

Derecognitionapproach

Underlying asset

Right-of-use asset

March 2011©Canadian Finance & Leasing Association 19

ED: Leases - Key impacts

•Leases “on balance sheet”– Increases in assets and liabilities– Impact on key ratios and covenants, impairment headroom

•Impact on profit or loss– Front-loading of expenses vs. increase in EBITDA

•New liability measurement basis– contingent rentals likely– Residual value likely– Reassessment → volatility– Judgement required

Lessees

Complexity and a costly transition©Canadian Finance & Leasing Association

March 201120

ED: Leases - Key impacts

•Alternative models:– Performance obligation approach

• front-loading of income• no upfront gain

– Derecognition approach• deferral of income relating to residual asset until sold/re-let• upfront gain/loss

•New asset measurement basis

Lessors

Complexity and a costly transition©Canadian Finance & Leasing Association

March 201121

March 2011

Canadian GAAP vs. Private Enterprise GAAP

• GAAP for Private Enterprises– Based on existing Canadian GAAP

• Similar requirements for lease accounting as current Section 3065


Tax Treatment for Leases

• No statutory description of what constitutes a lease

• Determination of whether a lease exists for tax purposes based on legal documents

The courts reference case law to determine whether a disposition and acquisition of property has occurred for Canadian tax purposes• Lease or• Purchase and sale transaction

23©Canadian Finance & Leasing AssociationMarch 2011

March 2011

Taxation of Lessee

• Rental payments are generally tax deductible if the transaction is deemed to be a “Lease”

• Interest portion of payment is tax deductible if the transaction is deemed to be a “Sale”

• Canadian tax depreciation may be claimed where the lessee is considered to have acquired ownership of the property, i.e. a “Sale”


March 2011

Taxation of Lessor

• Gross amount of all lease rentals earned during the taxation year from each of its leases

• Lessor can deduct any current expenditure such as general administration and overhead expenses of a capital nature

• Interest is generally deducted in determining income for tax purposes provided:– Borrowed funds were used for producing income– Interest amount was paid pursuant to legal

obligation– Total interest expense was reasonable


March 2011

Tax Depreciation

• Capital Cost Allowance (CCA) is statutory method for writing off the cost of assets to determine income for tax purposes

• Categorized into various classes according to the type of asset

• Depreciable rate for each class established max amount of tax depreciation in a taxation year

• Cost of individual assets are grouped on a pooled basis


March 2011

Tax Depreciation

• Income Tax Regulations limit the maximum amount of tax depreciation available in the year the asset is acquired to one-half of the normal amount

• For a leasing company, tax depreciation can be claimed at the time the lease starts


CCA Example

Lessor leases a phone system for $20K over 3 years

Asset class is 8 with a tax depreciation rate of 20%

Year 1 $20,000 x 20% = $4,000 ÷ 2 = $2,000Year 2 $18,000 x 20% = $3,600Year 3 $14,400 x 20% = $2,880

March 2011 28©Canadian Finance & Leasing Association

March 2011

Sales Tax Summary

Leasing companies, and therefore Lessees, aresubject to various sales taxes in Canada • Goods and Services Tax (“GST”)• Harmonized Sales Tax (“HST”)• Quebec Sales Tax (“QST”)• Provincial Retail Sales Taxes (known as “PST”)

No distinction between capital/financing and operating leases

• PST can be exempt in certain situations


March 2011

Canadian Sales Tax Rates


Province GST HST PST TotalAlberta 5% - - 5%British Columbia - 12% - 12%Manitoba 5% - 7% 12%

New Brunswick - 13% - 13%Newfoundland and Labrador

- 13% - 13%

Northwest Territories 5% - - 5%

Nova Scotia - 15% - 15%

©Canadian Finance & Leasing Association 31

Canadian Sales Tax Rates


Province GST HST PST TotalNunavut 5% - - 5%Ontario - 13% - 13%Prince Edward Island 5% - 10%1 15.5%

Quebec 5% 8.5%1 13.925%

Saskatchewan 5% - 5% 10%

Yukon Territory 5% - - 5%

March 2011

GST & HST Overview• HST is a total tax at a combined rate

• GST/HST applies to every transaction throughout the distribution chain• Input Tax Credits

• GST is applicable if the property on lease is delivered or made available in Canada to the Lessee

• HST is applicable based on specific ‘place of supply’ rules that differ depending on the type of property supplied and the duration of the lease



QST Overview

• QST is a multi-level transaction based tax that applies to every transaction throughout the distribution chain– QST Input Tax Refunds

• ‘Place of Supply’ rules for determining whether a supply is subject to QST are similar to HST rules

A lessor must register for QST in Quebec prior to entering into the lease agreement with the lessee



PST Overview

• PST applies to purchasers of tangible personal property by way of sale, rent or lease– Only applies to the final consumer or user

• Exemptions exist and vary across the PST provinces

• Place of Supply rules to determine whether retail sales occurs in a province are unique to each province

PST is not recoverable34©Canadian Finance & Leasing AssociationMarch 2011


Cross-border Considerations

• GST/HST registration is required where non-resident is carrying on business in Canada

• QST registration is required where non-resident is carrying on business in Quebec

• For PST, a lessor that is a non-resident of the particular province is required to obtain a vendor registration



Customs Duty Implications

• Origin of the imported goods must be determined

• Goods imported from U.S. are generally covered by NAFTA

• Where customs duty is applicable, it is paid by importer of record

• Any GST/HST payable on imported goods is payable by importer of record


March 2011

Summary

Classifying leases from an accounting perspective differs from legal classification

Implications on financial statements differ depending on the type of lease and differ from Lessee to Lessor

Lease classification for income tax purposes can vary from accounting classification

For Sales Tax, there is no differentiation between different lease classifications


Financial and Tax Accounting for Leases & Sales Tax Implications of Leases

Financial and Tax Accounting for Leases & Sales Tax ... · PDF filefor Leases & Sales Tax Implications of Leases. ... Treatment for Leases Sales Tax ... throughout the...

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