As previously reported upon in Tax matters of 22 June 2017, the Swedish Government has distributed for consultation an extensive memorandum with proposed changes in tax regulations in the corporate sector. This memorandum contains, amongst other things, proposals for special tax rules for financial leasing, the implementation of which will result in major changes compared with the current tax treatment.
The term ”financial leasing” is usually used when a leasing agreement implies that the economic advantages and risks associated with the ownership of a leased object are transferred, in all significant aspects, from the lessor to the lessee even if the formal right of ownership remains with the lessor. In spite of such an agreement formally is a rental agreement, its economic effects are very close to the effects of a purchase financed via a loan. Leasing agreements which are not financial are referred to as operational leasing agreements – that is, leasing agreements whereby the economic advantages and risks remain, to a major degree, with the lessor.
Current tax practice implies that leasing agreements be treated, in the majority of cases, in accordance with their formal content, that is, as rental agreements. This implies that the lessor, as owner of the leased asset, makes depreciations and is taxed for the entire leasing fee, while the lessee can deduct the entire leasing fee. This can be compared with a loan financed purchase whereby the borrower becomes the owner of the asset and can deduct depreciations, as well as being able to deduct interest, but not amoritisation.
Accounting rules for financial leasing
In accounting regulations (BFNAR 2012:1 Annual accounting and consolidated reports, K3 and RFR 2 Accounting for Legal Entities) there are varying rules for reporting financial leasing in terms of whether such reporting applies to a legal entity or to reporting in consolidated accounts. With the reporting of legal entities, all leasing agreements may be treated as operational, that is, as rental agreements. On the other hand, in consolidated accounts a difference is made between financial and operational leasing agreements whereby the agreements are treated according to the economic implications of the transaction in question. If the terms of the agreement are such that, in practice, it is a question of a purchase, the lessee is to report the asset in its balance sheet in the consolidated accounts together with an equivalent debt, and is to report depreciation of the asset. The lessor which, in formal terms, owns the asset, is to report a receivable with the lessee. The leasing fees are to be allocated according to one portion which is interest and one portion seen to comprise the amoritisation of the debt. The lessee expenses the interest but not the amoritisation and the lessor, in an equivalent manner, only include the interest in the income. In the Swedish Accounting Standards Board’s simplified regulations for smaller companies (K1 and K2), there are no special rules for financial leasing agreements.
Proposal for new tax regulations for leasing, in brief
As a result of the proposal regarding a general limitation on right of deduction of interest expenses which we have previously reported upon, and as the economic implication of leasing can be seen to be equal to the lending of funds, the Government is of the opinion that it is necessary to also introduce specific rules regarding the fiscal treatment of leasing. The Government believes that, if such an introduction of new rules is not undertaken, the provision of loans in the form of leasing agreements would imply that such transactions incur a more advantageous fiscal treatment than “usual” lending.
The Government’s proposal for new leasing tax regulations is comprised of special tax rules for financial leasing agreements in a new Chapter 20 b of the Act on Income Tax. These regulations have the general accounting regulations of K3 as their model. The treatment of agreements classified for accounting purposes as operational agreements will, therefore, be the same as previously.
The regulations are to be applied to inventories, equipment, buildings, land improvements and land included in financial leasing agreements. The proposed law text states that a financial leasing agreement refers to an agreement according to which (i) a lessor during an agreed upon period of time provides a lessee with the right to use an asset in exchange for payment, and (ii) the economic risks and advantages associated with the ownership of an asset are exclusively, or more or less exclusively, transferred from the lessor to the lessee. The memorandum states that the definition of the agreements to be covered by the rules should, as a starting point, be interpreted in the same manner as in determining the accounting treatment of such agreements, but it is noted that the fiscal definition is considered to comprise an independent definition. In other words, the tax rules are dissociated in order that the Tax Agency and courts can make an independent assessment and not be bound by the accounting treatment of the agreements in question.
For the lessee, the proposed regulations imply that the rights and obligations stipulated in a financial leasing agreement are to be treated as assets and liabilities. An asset is treated in the same manner as other assets of the same category, that is, it is subject to depreciations as applicable. The acquisition value of the asset is to be the lowest of the asset’s fair value and the present value of the minimum leasing fees determined in conjunction with the establishment of the leasing agreement. The minimum leasing fees are defined as the total of (1) the amount to be paid by the lessee to the lessor during the leasing period, and (ii) the residual value guaranteed by the lessee or by an associated company. If the leasing fees include a variable fee which is comparable with interest expenses, this variable fee is to be included in the minimum leasing fees according to the interest rate applying when the agreement was first established. Fees directly attributable to the establishment and arrangement of the leasing agreement are also to be added to the acquisition value. Other variable fees are to be deducted according to generally accepted accounting practice and if they incorporate the same function as interest, they are to be treated as interest expenses. The proposal also contains regulations as to the manner in which the present value of minimum leasing fees is to be calculated, and also contains a definition of fair value.
Furthermore, the lessee is to allocate the minimum leasing fees to interest and the amoritisation of the debt. The interest is to be allocated over the leasing period by calculating an amount of interest for each income year equivalent to a fixed interest rate applied to the debt reported during each respective income year.
The Government maintains in the proposal that for companies currently applying K3 or RFR 2 and who prepare consolidated accounts, a tax rule covering all financial leasing agreements does not imply additional work. However, for companies with leasing agreements and who apply K2, the new regulations will imply additional work as they will be required to capitalize the leased assets and will need to break out the interest component from the leasing fees. Due to this, the Government deems that a simplification rule should be introduced, and proposes that the new rules do not need to be applied if the total leasing liability for all associated companies is less than three million krona.
For lessors, the proposal implies that the leased asset is not to be treated as an asset. Instead, the lessor is to report a receivable according to a financial leasing agreement. The acquisition value of the receivable is to be equivalent to the present value of the total minimum leasing fees and the portion of the leased asset’s residual value which is not guaranteed and which belongs to the lessor when the agreement is terminated. In addition to that which has been stated above shall be included in the minimum leasing fee, the lessor are also to include any residual value guaranteed by a third party. The lessor is to allocate the leasing fees to interest and amoritisation of the receivable and is to calculate interest for each income year so that an even interest yield is achieved.
In order to deal with the case in which the lessor has manufactured the asset or is the retailer of the asset, a rule has been proposed which expressly states that the asset is taxed by the lessor if it is the subject of a financial leasing agreement. A special regulation is also proposed for sale-and-lease-back transactions implying that the profit or loss arising in such a transaction is to be reported, respective deducted on a straight-line basis, over the leasing period.
If the proposed rules for financial leasing agreements actually come into effect, this will imply a major change for both lessors and those lessees who are not covered by the simplification rule. Today’s accounting rules for smaller companies are adapted to the fiscal treatment now in place. If the asset is to be seen to have been transferred to the lessee in a financial lease, it will, as a result, be more complicated for smaller companies provided there is also no adaption of K1 and K2. A further question is if the voluntary exemption in legal entities in K3 and RFR 2 can continue to apply if these new regulations come into effect.
Furthermore, this change will probably impact the pricing of financial leasing agreements as the tax credit incurred by the lessor today through the possibility of reporting fiscal excess depreciation will no longer apply. This has also been noted by the Government who, consequently, proposes that the regulations only to apply to financial leasing agreements entered into after the new rules have come into effect, that is, from 1 July 2018. The proposed transition rules state, however, that the interest portion of the leasing fees is also to be specified for agreements entered into prior to this date and are to be covered by the general limitation on deduction of interest expenses.
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