It’s official - complexity caused by the 35-page section of the Corporation Tax Act 2010 dealing with leasing of plant and machinery has a bigger impact than any other part of the UK’s 6,100 pages of primary tax legislation.
That’s the verdict of the Office of Tax Simplification’s (OTS) first complexity index, published at the end of last week. Having looked at 107 areas of the tax system, the five-person OTS staff’s professional judgement is that the area with the biggest impact of complexity is - leasing.
The OTS, part of HM Treasury, gives independent advice to the government on simplifying the UK tax system. Its complexity index attempts to measure policy, legislative and operational complexity and then the impact of all that complexity.
Lease taxation doesn’t come out too badly for its policy or legislative complexity. The rules have been relatively stable in recent years. However the guidance available to taxpayers and the information needed by them lead to high operational complexity.
All four measures of impact of complexity – the cost per taxpayer to HMRC, number if taxpayers affected, average ability of taxpayers to follow the rules and guidance, and error, evasion and avoidance risk – score at the top of the range. This results in the overall impact of complexity being a (not so) perfect 10.0 - uniquely across all of the 107 areas of the tax system.
The OTS’s complexity index is itself far from straightforward and the OTS acknowledges some of the results may be inaccurate. It’s not clear whether the index is based on the ‘average’ lease transactions or only larger deals. However it’s still the first time that lease taxation has been scored in this way, so it could be important.Will the OTS index encourage the government to simplify how leases are taxed?
HM Treasury (HMT) and HMRC are understandably reluctant to change the rules. It’s only in the recent years that big-scale leasing tax avoidance schemes promoted by the audit firms and others have been stopped.
To be clear, such schemes had very little to do with genuine leasing, and there’s an argument that anti-avoidance measures have gone too far and harmed the UK economy.
However HMT and HMRC now have to deal with the implications of the IASB’s new lease accounting standard that is due to be finalised by the end of this year. UK lease taxation is closely tied to the accounting rules. Changes to lease taxation are inevitable once the IASB delivers the new Standard.
In 2011, when it appeared the IASB was getting close to issuing a new Standard, legislation was rushed through Parliament to ‘freeze’ the existing tax rules. As a result of an amendment to the Finance Bill 2011, references to accounting standards in the tax rules will ignore the new international accounting standard.
The ‘freezing’ approach further increases complexity for taxpayers. Companies would have to keep two separate sets of accounts for their leases. Furthermore the existing accounting rules would also need to be copied across into the tax legislation. The Finance Act amendment was never intended as anything more than a temporary fix.
The challenge for HMRC now is to deal with the new accounting standard in a way that doesn’t open the door to new avoidance, but also simplifies leasing taxation and moves it off the top of the OTS complexity index.
The scale of this challenge was reflected in HMRC’s public response to the 2013 Exposure Draft which identified “significant concerns”. HMRC said: “We note that the Exposure Draft again proposes to remove what seems a sometimes arbitrary distinction between finance leases and operating leases – a distinction which leads to a significantly different accounting treatment for transactions with (around the borderline) similar underlying features.
The distinction is, however, a long-standing one, is embedded in many business practices, and is well understood and generally well applied across the broad base of UK business.”
Does HMRC need to worry about a new lease accounting standard?
Certainly the IASB is on a mission now to complete its new Standard by the end of this year. However the European Financial Reporting Advisory Group (EFRAG – the body that advises the European Commission on new IASB standards) still wants to see some improvements made.
EFRAG’s Annual Review was published this month and describes EFRAG’s concerns, together with the work it has carried out over the last year to influence the IASB’s work.
The Review notes in unusually pointed terms: “These supplementary efforts have not had any direct influence on the final decisions made by the IASB.
Time will come in 2015 when the EFRAG Board has to consider the final IFRS lease standard for endorsement in the EU.”
Last week EFRAG published a letter it had sent to the IASB calling for a public ‘fatal flaws’ review of the new Standard (usually only the in-crowd of audit firms and other technical experts are involved in the IASB’s ‘fatal flaw’ review of new standards).
EFRAG said it “believed that significant judgment will be needed to apply the forthcoming Leases Standard and, unless entities are able to properly understand and apply the new requirements including the definition of a lease, there will be a significant and wasteful use of time debating possible interpretations, which will lead to a real risk of divergent application.”
This pressure on the IASB to improve the new standard follows Leaseurope’s ongoing work keeping EFRAG informed of the industry’s concerns over lease definition and other aspects of the new standard. Leaseurope has called for the new standard to exclude agreements where the actual vehicle or equipment being used is unimportant.
Given EFRAG’s stand, it’s not clear whether the IASB will still hit its target for publishing the new standard by the end of this year. We could then see publication slip to 2016 - just in time for the 10th anniversary of the IASB’s leases project.
Whenever the IASB does complete its new leases standard, and assuming it is eventually adopted for use in the European Union, the focus of attention in the UK seems likely to shift to tax. The new OTS index could then persuade HMRC to take the opportunity to remove some of the complexity that exists today.
Julian Rose is Director of Asset Finance Policy, a specialist consultancy helping finance companies to monitor, interpret and respond to policy and regulatory matters (www.assetfinancepolicy.co.uk). He is also adviser on lease accounting policy with Leaseurope.