FRS 16 Leases requires that the right of use asset (ROU) and the lease liability should initially be measured at the present value of the minimum lease payments (MLPs). IFRIC were asked to consider how irrecoverable Value Added Tax (VAT) charged on lease payments should be accounted for, given IFRS 16 is silent on the matter. Should the irrecoverable VAT be included in or excluded from the valuation of the ROU and the present value of the MLPs?
In the fact pattern described in the request:
- The lessee operates in a jurisdiction in which VAT is charged on goods and services. A seller includes VAT in an invoice for payment issued to a purchaser. In the case of leases, VAT is charged when an invoice for payment is issued by a lessor to a lessee.
- The applicable legislation requires a seller to collect VAT and remit it to the government and generally allows a purchaser to recover from the government VAT charged on payments for goods or services, including leases.
- However, because of the nature of its operations, the lessee can recover only a portion of the VAT charged on purchased goods or services. This includes VAT on payments it makes for leases. Consequently, a portion the lessee pays is non-refundable.
- Lease agreements require the lessee to make payments to the lessor that include amounts related to VAT charged in accordance with the applicable legislation.
IFRIC undertook a technical analysis and research and received numerous responses from members of the International Forum of Accounting Standard-Setters, securities regulators, and large accounting firms on how irrecoverable VAT should be accounted for. The outreach conducted by IFRIC provided limited evidence that non-refundable VAT is material to affected lessees and of diversity in the way lessees in similar circumstances account for non-refundable VAT on lease payments. Consequently, IFRIC tentatively decided not to add a standard setting project to the work plan.
A final agenda decision is yet to be reached by IFRIC.
The issue at hand
Despite its overall principle being to achieve the same presentation for assets leased as for assets purchased, IFRS 16 is silent on the matter of how irrecoverable VAT should be accounted for. This particularly affects entities in sectors where outputs tend to be VAT exempt or where there are restrictions on the recovery of VAT due to private usage in many jurisdictions.
The question arises whether VAT should be considered as part of the lease payments or whether it is a separate levy. It’s also not clear whether the VAT amount should be capitalised or expensed. The timing of when this amount is recognised should also be considered.
Our preferred view
In the fact pattern described in the request, the VAT is a tax that is levied on the lessee and collected by the lessor who is acting as agent of the government. Consequently, in our view, the VAT is not a lease payment (irrespective of whether it is irrecoverable or not) as the payment is not made to the lessor in exchange for the right to use the underlying asset. Rather we consider the VAT should be accounted for as a levy in accordance with IFRIC 21 Levies. The obligating event in the fact pattern described is the issue of each periodic invoice by the lessor. Therefore, the lessee should recognise a liability for each VAT payment on each invoice date and not at commencement of the lease. IFRIC 21 does not address whether any irrecoverable VAT gives rise to an asset or an expense. The lessee should first consider whether the irrecoverable VAT is an initial direct cost, in which case it will be capitalised into the ROU asset. Otherwise, we consider the lessee has an accounting policy choice to capitalise the irrecoverable VAT by analogy to the requirements in IAS 16 Property, Plant and Equipment dealing with similar issues or to expense it as incurred.