Lease accounting proposals: howwill the industry respond? by Tim Schelle

Asset finance - legal and regulatory update May 2013 LEASE ACCOUNTING

Lease accounting proposals: how will the industry respond? he second exposure draft

charges (front loaded) and

(ED2) of the long planned

amortization payments (on a straight

lease accounting standard

line basis); or

2013). The joint standard setting

case where the rental profile is level

bodies – the International Accounting

from year to year), as with current

Standards Board (IASB) and the US

operating leases, and perhaps with

Financial Accounting Standards

all expense to be presented as rental

Board (FASB) – have spent a great

rather than a combination of finance

deal of time re-deliberating the

charges and amortization.

should be issued this week (May 16,

proposals since the first exposure draft (ED1) issued in 2010. The development of the new

- fully straight line (at least in the

Corresponding issues potentially arise with the income recognition profile in lessor accounting (see

standard has been an open process,

below), but the lessee side P&L

and there will be no surprises in the

expense profile has been the more

substantive proposals in ED2. The

critical issue.

core objective of this project has been to require the balance sheet

Current proposal for lessees

capitalization of all leases by lessees, removing their off-balance-sheet

The ED2 proposal for lessees will be

treatment for contracts with

as agreed by the Boards last June. It

substantial unguaranteed residual

will be based on an equipment

values (RVs) currently classified as

versus real estate split. The great

operating leases. The only

majority of equipment leases would

exceptions will be “short term

be accounted for on the front loaded

leases” (STLs), defined as those

expense profile like current finance

which can in no circumstances

leases; while most property leases

continue for more than 12 months.

would be on a straight line basis

The thorniest issue in the Boards'

(presented as a single rental

deliberations has been that of

expense) like current operating

accounting for periodic lease

leases.

expense in the profit and loss (P&L)

There would be some exceptions

account or income statement, on

on either side, based essentially on

capitalized leases. The question is

residual value (RV) type criteria. Thus

whether the expense profile should

some very long term property leases,

be:

such as the 99-year contracts that

- front-end loaded, as with current

are common in the UK, would be

finance leases which are already on-

accounted for like most equipment

balance sheet, with the overall

leases. A much narrower range of

expense broken down into finance

equipment leases (with exceptionally

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Asset finance - legal and regulatory update LEASE ACCOUNTING

high RVs, yet not sufficiently short

Last month FASB held a final pre-

loaded in the case of finance leases

term to qualify for off-balance-sheet

ED2 meeting without the IASB to

with zero RV to almost completely

treatment as STLs) would be treated

review the model from the standpoint

straight line for those leases (mainly

like most real estate leases.

of complexity issues. They agreed

of real estate) where RV is

only by the narrowest possible

exceptionally high but which are not

document to accompany ED2, the

margin of a 4-3 vote to proceed with

within the scope of STLs. However,

Boards are likely to argue that

ED2; and they decided to conduct

this would have been very complex

equipment leases are not intended to

intensive fieldwork with account

for lessees to operate, since they

be treated inconsistently with

preparers and users in the USA on

would have had to estimate RVs or

analogous property leases. They will

the viability of the income statement

useful lives of the leased assets; and

suggest that the asset type split is

approach in ED2 during the comment

it was firmly rebuffed in the outreach

merely an expedient for the starting

period.

exercise.

In the “Basis for Conclusions”

point in separating leases with high

The IASB has now decided to join

If the Boards could be persuaded

and low RVs, since equipment leases

in this new proactive outreach

to move away from their current

do normally have relatively low RVs

process, so it will be global in scope.

expensing proposal, the most likely

compared with leases of non-

In any event the global equipment

alternative would seem to be a

depreciating real estate.

leasing industry will need to consider

reversion to what the joint Boards

Thus the objective is to split leases

its response to ED2, and its

briefly favored early in 2011, towards

according to relative RVs. However, it

prevailing view seems likely to be

the beginning of the re-deliberation

will represent a deliberate “moving of

unfavorable towards the equipment

process after ED1. This would be to

the goal posts” compared with

vs real estate split in the P&L

allow straight line expensing for all

current lease classification, where

expensing model.

operating lease type contracts, while

only the contracts with low RVs are treated as finance leases. Under the

finance leases would be “scoped One model or two?

ED2 proposals only those with

out” from the new leasing standard and defined as “in-substance

particularly high RVs will be treated

It seems clear from all the Boards'

purchases” (i-SPs) rather than

like current operating leases – though

deliberations to date that none of the

leases.

most real estate leases will still be on

standard setters would consider it

that side of the line.

appropriate for current finance leases

lease classification “goal posts”

to be expensed in the same way as

might stay where they are under the

Boards had reached a deadlock on the

the straight line approach that they

current IAS 17 standard. Whenever a

P&L expensing approach, they

now accept for most property leases.

retention of current lease

identified three alternative options

In that sense a truly single model for

classification was tentatively

which were subjected to intensive

expensing is not on the agenda.

proposed (for either lessee or lessor

“outreach” consultations with a sample

However, this does not necessarily

accounting or both) , the two Boards

of lessees, lessors and users of

mean that the Boards could not be

concurred on the point that the

accounts. All three alternatives received

moved from the idea of a specific

“principles based” test in IAS 17,

negative feedback; and the Boards

equipment vs real estate split in a

rather than the numerical tests in the

then agreed on the current proposal.

lease classification method.

US equivalent Topic 840 (formerly

In April-May 2012, after the two

It has taken almost another year to

There was only one stage when a

Under this possible solution, the

FAS 13), should be the basis for

agree on some consequential changes

true single model for lessee

in other aspects of the draft standard,

expensing was under consideration.

and to complete the drafting of ED2. In

This was the “underlying asset”

accounting rules for i-SPs would

the meantime, however, the favored

approach favored by the IASB early

remain substantively as they are for

P&L expensing method has not been

last year. It would have resulted in a

finance leases; but they would be

field tested like the alternatives

“seamless robe” continuum of

derived from the principles in

rejected earlier.

expensing profiles, from fully front

separate standards. For lessees the

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convergence. If this alternative were adopted, the

Asset finance - legal and regulatory update LEASE ACCOUNTING

relevant standards would be the

profile, similar to the current rules for

developed; but also at key stages of

respective ones (in International

finance leases.

the subsequent re-deliberation.

Financial Reporting Standards (IFRS)

For leases currently classified as

Whenever the standard setters

and US GAAP) for accounting for

operating leases, the R&R basis will

have considered the specific issue of

property, plant and equipment (PPE).

be seen by many lessors as an

symmetry between the two sides,

If scoping-out of i-SPs were also

improvement on current rules. This

most members of both Boards have

applied on the lessor accounting side

will be particularly true for captive

tended to say that while symmetry

(which would not necessarily follow),

lessors and their corporate groups.

was seen as desirable if possible, it

the relevant principles for lessors

Current accounting rules prevent the

should not be pursued at the

would be found in the converged

recognition of a normal up-front

expense of obtaining the most

revenue recognition standard, which

selling profit, where a captive group

appropriate outcome on either side.

is about to be issued (following what

sells equipment on an operating

was originally a parallel project to the

lease. The R&R model will allow such

expressed the view that the existing

one on lease accounting).

selling profit recognition for the lease

lessor accounting model does not

receivable element of the sale,

necessarily need fundamental

deferring it only for the RV element.

change in the sense that they feel the

While dispensing with a split model within the lease accounting standard itself, this alternative would not of

The ED2 proposals will embody a

Many Board members have

lessee side does in the absence of

course truly represent a single lessee

symmetry principle as between the

full balance sheet capitalization.

accounting model. Some would see

lessee and lessor sides. For the bulk

Many have acknowledged that lessor

it as unsatisfactory to have the

of equipment leases front-loaded

accounting should reflect the

accounting rules for i-SP

lessor income recognition under R&R

business models of lessors rather

transactions located outside the

will broadly match the front-loaded

than just reflecting contract features

lease accounting standard, when

expense profile for lessees – while for

that suggest particular solutions on

many of these facilities (such as

most real estate leases there will be

the lessee side.

finance leases with no purchase

straight line P&L accounting for both

option in the UK market) are within

parties.

the general definition of leases for

Lessee and lessor accounting rules are both important considerations for

This linkage is a factor that the

the leasing industry. However, in

both commercial and all legal

leasing industry will need to consider

exploring alternative solutions the

purposes.

in framing its response to ED2. While

two are not necessarily closely

most equipment lessors will consider

linked.

Others in the leasing industry might feel that “scoping out” i-SPs and

the lessee side proposals in ED2

permitting straight line lessee

unsatisfactory, they may also see

expense profiles for all current

risks that a major change on the

operating leases would be a better

lessee side could have unwelcome

The Boards seem unlikely to give

outcome than accepting the

repercussions for the lessor

ground on the essential principle of

equipment vs real estate split that will

accounting model.

comprehensive capitalization for

be put forward in ED2.

Though it will in effect be proposed

Other issues

lessees. Some respondents to ED2

in ED2, strict symmetry between

may argue for the scope of the STL

lessee and lessor accounting has not

exemption to be widened, and

been an overriding objective of the

perhaps extended to leases running

On lessor accounting the ED2

Boards. During the long gestation

for up to two or three years – or

proposals will generally be welcomed

period of the new standard there

perhaps to “non-core assets” such

by the leasing industry. In nearly all

were several stages when there was

as vehicles or office machinery taken

equipment leases the lessor would

no such symmetry in the latest

on lease by a typical business

be subject to the “receivable and

tentative proposals. This was true of

outside the transport or IT sectors.

residual” (R&R) model. This provides

ED1, in which the lessor side

However, unless such suggestions

for a front loaded income recognition

proposals were not at all well

met with wide support from users of

The lessor side

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Asset finance - legal and regulatory update LEASE ACCOUNTING

accounts as well as lessors and

To date, the global accounting

for the transitional application of the

lessees, the standard setters may

standard setters have taken the view

new rules to pre-existing lease

find them unpersuasive. To date, they

that this aspect is not their problem,

contracts. Given the continuing

have taken the view that the

and that bank regulators can resolve

proposal to front-load expense on

materiality condition which qualifies

it by clarifying their own rules on

contracts currently classified as

all accounting rules is sufficient to

intangible assets. However, some

operating leases, the originally

address the problem of complex

national accounting standard setters

proposed transition rules would have

accounting rules for leases that are

have supported the leasing industry's

given rise to a heavy incidence of

on an insignificant scale.

contention that the ROU should be

reported losses in the initial years of

classified as a PPE asset.

application of the new standard.

There will nevertheless be a number of specific issues in ED2,

Many of the proposals agreed by

However, the “modified retrospective

beyond the main lessee and lessor

the Boards for ED2 have been

approach” now proposed would

accounting models, on which

generally welcomed in the leasing

alleviate that problem.

respondents in the leasing industry

industry. The proposals for

could usefully comment.

accounting for possible lease

scope, there is one aspect of the

The Boards have declined to clarify

Though much more limited in

renewal periods, and for other

proposed transition rules in lessor

whether the lessee's “right of use”

contingent rentals, have been greatly

accounting that seems clearly

(ROU) asset should be regarded as a

simplified compared with ED1.

anomalous. This concerns operating

tangible PPE asset or as an

The rules for recognizing

lease portfolios that will have been

intangible asset. This would make no

“embedded leases”, within what

securitized prior to transition, within

difference to accounting rules in

might otherwise be viewed as pure

the accounts of the originating

themselves, but it could become a

service contracts, have been made

lessors.

very significant issue for banks as

much clearer. The proposed

lessees. Under the Basel III rules for

accounting rules for what are more

accounting the lessor recognizes the

measuring banks' regulatory capital,

clearly service-inclusive leases have

underlying leased asset on its

through changes to be phased in

also been simplified; as have those

balance sheet, rather than the lease

over the four years up to 2018,

for sale and leaseback transactions.

receivables. If the bulk of the

intangible assets will have to be

It is now clear that three of the

Under current operating lease

receivables' value is sold to a third

deducted from capital. This

seven FASB members, together with

party funder in a securitization deal,

represents a severely adverse

probably a smaller proportion of

this is accounted for as a secured

treatment compared with that for

IASB members, will be attaching

borrowing. The lessor recognizes the

tangible PPE assets in bank

formal notes of dissent to ED2,

cash proceeds from the funder and a

infrastructure, which are merely

criticizing particular features of it.

corresponding financial liability to

subject to a standard weighting as

However, these dissenting notes are

that party.

risk assets comparable with typical

unlikely to be viewed with favor in the

credit exposures.

leasing industry, as some will

the R&R lessor accounting model,

This Basel III change seems

It is proposed that on transition to

suggest changes that would make

the full lease receivables outstanding

primarily targeted at quite different

the rules more complex for lessees,

at the time would have to be newly

types of intangible assets, notably

in such areas as lease renewal

recognized. They would be

goodwill arising on accounting for

periods, contingent rentals or

presented on the balance sheet as

corporate acquisitions; but it extends

disclosure rules.

lease receivables pledged to lenders,

to all intangibles, and so could affect the ROU if it were so regarded, This

in line with the required presentation Transition rules

for secured borrowings.

leases, though the major impact

On the lessee accounting side the

corresponding transition treatment of

would be on real estate leases in bank

Boards have agreed a considerable

previously securitized finance lease

head offices and branch networks.

improvement to the ED1 proposals

or loan receivables, nor with the

problem potentially affects all kinds of

This is not consistent with the

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Asset finance - legal and regulatory update LEASE ACCOUNTING

future treatment under R&R of

incorporated in a future edition of

securitizations of leases that would

IFRS SMEs; but it is only at that

be currently classified as operating

stage that most unlisted companies

leases. In all those cases the portion

subject to IFRS will become subject

of receivables on which risk had

to the new rules for leases. In view of

been transferred to the funder would

the current cycle for updating IFRS

be de-recognized by the originator.

SMEs the effective date for them

The staff report on this subject

could be January 2018 or even later.

received by the Boards, when it was

In most EU countries unlisted

considered in November 2011,

companies are not subject to

identified possible solutions that

mandatory compliance with IFRS but

seemed more equitable. However, for

are able to use national GAAPs. In

various reasons the Boards rejected

some of those countries, including

these.

the UK, Spain and Ireland national GAAP rules are kept quite closely

Operative dates

aligned with IFRS. However, here again there may be some delay

There will be a four-month period

before the new converged lease

allowed for comments in response to

accounting standard is reflected in

ED2, so this should run until some

the national rules.

time in September. The Boards will then need some further redeliberation. Even if no major further changes were agreed, it seems unlikely that the new standard could be finalized and issued before December of this year at the earliest; and it could take much longer. The most likely final effective date of the new lease accounting standard is January 1 2017. The “dates of initial application”, from which listed company lessees and lessors will have to file prior year comparative information on the new basis, would then be January 2015 for those in the USA and January 2016 for those in the EU. Depending on national regulations, most unlisted companies reporting under IFRS could be subject to the special IFRS standard for smaller businesses (IFRS SMEs). The current edition of IFRS SMEs reflects the full requirements of IAS 17; and it is likely that the rules of the new lease accounting standard will be

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Asset finance - legal and regulatory update BANK REGULATION

Bank regulation: part of the backdrop to asset finance anking regulations continue

January 1 2014, so that the first two

that changed in Basel III compared

to evolve in the backwash of

annual phases of Basel III will be

with Basel II – those banks will still not

the global credit crisis of

implemented together in Europe.

be held to current global standards.

specifically focused on asset finance,

EU will permit higher levels of

higher minimum buffers for the

the leasing industry will be affected

minimum capital to be applied across

narrowest “core Tier 1” definition of

since banks and their subsidiary

the board in those member states

capital. Additional minimum capital

companies play such a dominant role

where national regulators wish to

buffers for some 30 of the largest

in advancing or funding asset finance

exceed the mandatory EU

banks which meet the criteria of

facilities in most national markets.

requirements, though this will be

“global systemically important banks”

subject to agreement by the European

(G-SIBs), whose failure would cause

Commission. The UK and Sweden

significant dislocation in international

pressed for the right to take this action,

markets, will be phased in between

At global level the changes in bank

which would have been precluded by a

2016 and 2019. The Financial

solvency rules agreed under the

“maximum harmonization” principle in

Stability Board (FSB), set up by the

Basel III package started to take

earlier drafts of CRD IV.

Group of 20 (G20) countries, has now

2008. Though the changes are not

Solvency rules

effect at the beginning of this year.

The agreement finally reached in the

Beyond Europe, Japan

Significant increases in the regulatory

implemented the first phase of Basel

minimum levels for shareholders'

III at the end of March.

capital in relation to banks' credit

However, the USA has still to

The main emphasis in Basel III is on

identified the banks to be initially classified as G-SIBs. The Basel Committee of Banking Supervision (BCBS) has also adopted

exposures will mostly be phased in

finalize its Basel III requirements for

requirements for national regulators

over a six-year period up to January

the limited number of “core banks” to

to apply similar extra capital buffers,

2019, with some elements of the

which they will be mandatory, and

on the same time scale, for other

package taking a further three years.

some other “opt-in” banks who

large banks defined as “domestic

The agreed commitment among all

adhere to the full Basel regime

systemically important banks” (D-

major countries is to apply the Basel

voluntarily. The core and opt-in banks

SIBs). These will be defined by similar

rules to “internationally active banks”.

account for the great bulk of the

criteria to those for G-SIBs –

The European Union goes further,

international business of US-based

concentrating on size,

requiring member states to apply the

banks, but not for the bulk of

interconnectedness, substitutability

Basel rules to all regulated banks.

domestic US banking. The mandatory

and complexity - but from the

However, most major jurisdictions are

requirements for non-core US banks

standpoint of national rather than

running a little late in completing the

are currently based on the first (Basel

international consequences of

local rules to implement Basel III.

I) global agreement.

possible bank failures. Compared

The EU reached final agreement on

From January 2015 the non-core US

with the rules for G-SIBs there will be

the outlines of the CRD IV directive

banks will be brought more into line

more national discretion on the D-SIB

and associated regulations for this

with the risk asset weighting (RAW)

regime, but national regulators will be

purpose in February this year.

requirements of Basel II, which for

required to publish details of the

However, it will take member states

most banking transactions have not

adopted frameworks.

until mid-year to adopt the national

been changed by subsequent Basel

legislation required by CRD IV; and

agreements. However, in terms of

from the scope of regulatory capital

these will not be made effective until

minimum capital levels – the element

some hybrid instruments between

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The Basel III changes will exclude

Asset finance - legal and regulatory update BANK REGULATION

debt and equity that are less loss-

For the first time from 2015 the

would not have been challenged by

absorbing than common

global Basel rules will incorporate

the LCR. However, many Euro zone

shareholders' equity.

minimum requirements for banks'

banks will face significantly higher

liquidity, as well as their solvency.

liquidity requirements when these

lessors and lease funders in the

Both of these factors played a part

two new rules come fully into effect.

banking sector are subject to the

in the onset of the global banking

“internal ratings basis” (IRB) model

crisis from 2007.

In all major countries most larger

The policy dilemma

for RAWs. The weightings of their

In January, however, BCBS

leasing exposures will reflect the

announced a major relaxation of

All elements of the Basel III package

security value of their retention of

one of the planned liquidity rules,

will constrain the credit capacity of

title in the leased asset, and will

the liquidity coverage ratio (LCR)

the banking sector, while hopefully

thus be more favorable compared

which will require banks to hold

making banks safer and more

with unsecured loans to customers

defined liquid assets matching a 30-

resilient and reducing the exposure

of comparable credit standing.

day outflow of funds. This will now

of sovereigns to any further rescues

During the course of this year BCBS

be phased in over four years,

of distressed banks considered “too

is due to consider a review of the

instead of being applied in full from

big to fail”.

regulatory consistency of RAWs on

January 2015. Perhaps more

banks' credit exposures from one

important, the range of permissible

agreed in 2009, it was assumed that

country to another.

liquid assets has been extended

the post-crisis recession in most

beyond sovereign debt to some of

national markets would be over by

new additional minimum solvency

the more readily marketable

the time that the new prudential rules

requirement, measuring banks'

exposures to private sector

started to bite. The latest concession

“leverage” - i.e. the relationship of

customers (with appropriate

on the LCR is the only instance to

shareholders' capital to unweighted

“haircut” discounts).

date where BCBS has rowed back

From 2018 Basel III will bring in a

gross assets. In some jurisdictions, notably the

Some securitized residential mortgage portfolios will now be

When the Basel III package was

on the earlier proposal in response to fears on the economic implications.

USA, unweighted leverage ratios

eligible assets for the LCR.

already play a part in bank solvency

However, this concession has not

countries, there are plenty more

rules. Some regulators in other

been extended to securitized motor

instances of the policy dilemma for

countries have come to the view

vehicle or equipment leasing assets.

the authorities as between

that the whole RAW system has

A further liquidity rule, the more

At the national level in many

strengthening banking capital and

become unnecessarily complex,

complex net stable funding ratio

encouraging banks to boost lending

and simple leverage ratios in fact

(NSFR) presently due to be

so as to stimulate economic activity.

give a better measure of true risk.

introduced from 2018, is also now

In the UK bank regulators have

under review and may be subject to

called for substantial re-

in parallel with the existing metrics

concessions in timing and/or in

capitalization by major banking

of capital in relation to weighted risk

substance. The NSFR involves

groups while at the same time

assets. In most countries, which do

weightings of the items on both

government is pressing them to

not currently have leverage ratios, it

sides of a bank's balance sheet to

expand lending.

will therefore trigger increased

match the value of wholly or

capital requirements for exposures

partially liquid assets against

scheme launched in the UK last year

attracting relatively low RAWs,

exposures to outflows from the

offers banks medium term lending

mainly those to customers with top

liabilities side.

facilities from the Bank of England,

The leverage ratio will be applied

quality credit ratings. Leasing

Banks in some jurisdictions,

The Funding for Lending (FFL)

on terms reflecting a margin above

portfolios with public sector

particularly the UK where relatively

UK sovereign funding costs, subject

customers are likely to be adversely

stringent liquidity rules are already

to qualifying conditions on the

affected.

applied by national regulators,

volume of net new advances.

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Asset finance - legal and regulatory update BANK REGULATION

Equipment leasing exposures by

of the Euro zone banking union

seen whether the UK authorities will

bank lessors have been included in

project. This includes the idea of a

implement this rule as required, or

the relevant credit aggregates, so

common deposit guarantee scheme

will perhaps mount a legal challenge

that FFL incentivizes leasing as well

for the Euro zone states. It would

to it.

as pure lending.

embody an element of “fiscal union”

Most bank lessors in the UK are

Meanwhile the UK has made

through a potential transfer of

important changes to its national

participating in FFL. However, the

resources from stronger to weaker

banking supervision regime. Last

possible advantage from it depends

member states of the zone, which

month the UK prudential supervisors

on the alternative funding costs of

naturally meets with resistance in

were transferred from the former

each bank. One major player (HSBC)

some countries.

Financial Services Authority (FSA) to

is not participating in FFL since it is funding itself more cheaply from its

a new Bank of England division, the The UK and Europe

retail deposit base, and is less

Prudential Regulation Authority (PRA).

dependent on wholesale funding

The Euro zone banking union

than its competitors.

agreement was reached by the EU as a whole. As part of it, the UK and

The Euro zone

other non-members of the Euro zone received some assurances that they

Last year the Euro zone states took

would not in effect face a block vote

the first steps towards a regulatory

from Euro zone countries in

“banking union” to shore up

decisions binding on the European

institutions in the distressed

Banking Authority (EBA) which

peripheral states which face a

oversees the implementation of EU-

challenging interaction of

wide banking supervision legislation

commercial banking exposures and pressures on their own sovereigns. The first leg of banking union is for

More widely, however, as host to the major international financial centre in Europe in the City of

the European Central Bank (ECB),

London, the UK has some concerns

which presently has no role in

about the possibility of being

prudential regulation, to take over

outvoted on banking and financial

some such responsibilities from the

market regulations by EU member

present national regulators.

states who are less critically involved

Some Euro zone states wished to

in global transactions.

see a wholesale transfer of these

An instance of this was seen in the

powers to the ECB, believing that

final decisions on CRD IV earlier this

only the assurance of a common

year, where limits on the relative level

standard of supervision would

of bonus remuneration in banks were

sustain confidence in some of the

added to the directive over the UK's

national markets. However, others

objections. These limits will tend to

resisted this. Under a compromise

make executive remuneration less

agreed at the end of last year, the

loss-absorbing, by increasing fixed

ECB will take over regulation of the

salaries relative to bonus pools; but

larger Euro zone banks from April

were nevertheless included in a

2014.

directive which was supposedly

However, there has been no progress to date on other elements

concerned with making banks more resilient to losses. It remains to be

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Asset finance - legal and regulatory update TAXATION AND LEASING

Taxation and leasing: a varied picture variety of current tax changes

response to the new accounting

encourage the use of leasing.

will have some impact on

standard. Apart from all the statutory

Enhanced fiscal depreciation may be

leasing transactions. Others

references to lease accounting, there

intended to stimulate fixed

will affect the broader fiscal

is currently a formal extra-statutory

investment in general, or for limited

environment for leasing companies

concession whereby lessees in the

periods as economic stimulus

and their corporate groups.

case of finance leases can obtain tax

measures; or they may favor narrowly

relief for leasing expense on a front

targeted types of plant investment,

loaded profile that matches current

for example for environmental

accounting rules, even though the

reasons.

Effects of accounting changes In some IFRS jurisdictions the

legally permitted expense comprises

proposed new accounting standard

the actual rentals which normally

company (if eligible to claim fiscal

could have tax consequences. For

follow a level profile. The leasing

depreciation) may often be able to

example, in the UK the tax rules

industry would expect this provision

make more effective use of the

contain references to finance leases.

to be extended to all future leases

relevant allowances when the

These have the same meaning in

subject to front loaded expensing.

customer chooses to lease,

current IFRS and in UK GAAP ; but

There could also be other countries

In any such case, a leasing

compared with the alternative of the

they will be affected by the new lease

where accounting follows IFRS, and

customer purchasing the asset

accounting rules.

where some lease taxation rules

outright and claiming the tax write-

reflecting IFRS concepts such as

offs itself. The equipment user will be

anticipated that the new accounting

lease classification would need to

unable to utilize tax reliefs if they are

standard might be finalized sooner

change with the new accounting

in a tax loss position.

than it has been in the event.

standard.

The UK tax authorities at one point

Consequently, “holding” provisions

In the USA by contrast the tax

In the USA enhanced Year 1 tax write-off rates, introduced as a

were adopted in tax law, freezing the

code as applied to leasing

stimulus measure in 2009, came to

IAS 17 lease accounting standard in

transactions seems impervious to

an end at the beginning of this year.

its current form for those corporate

changes in lease accounting rules.

However, the normal write-off rates in

taxpayers following IFRS for tax

However, the capitalization of

the USA, and in many other

accounting. The period of operation

operating leases under front loaded

countries, are still sufficiently

of these provisions was not

lessee expense profiles will

attractive to provide an incentive to

specifically limited, but they were

nevertheless give rise to major new

use leasing finance in some cases.

clearly meant to be transitional. It will

mismatches between reportable and

not be satisfactory for such a law to

taxable income streams for US

UK. The fiscal depreciation rates

remain in operation for any length of

lessees, with consequential deferred

have been reduced in the UK in

time after IAS 17 is changed, since

tax accounting issues.

recent years; and since last year the

taxpayers would then have to apply old and new lease accounting rules

main capital allowance (CA) rate has Fiscal depreciation incentives

simultaneously for tax and financial reporting purposes. Consequently there will have to be UK tax law changes at some stage in

This is much less true now in the

been reduced to 18 per cent on the “reducing balance” basis. This

In many countries there are examples

means that only 45 per cent of the

of favorable tax write-offs for plant

asset's value can be written off

and machinery which may indirectly

against taxable income in the first

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Asset finance - legal and regulatory update TAXATION AND LEASING

three years of an asset's life. Rules in

objections from other member

force since 2006 mean that for

states, including the UK and

certain types of longer term lease

Sweden.

with limited RVs, only lessees rather

before the FTT proposal is finalized. Wider tax issues

In the case of securitization deals, which for various reasons are

Since 2010 several European

invariably structured as multi-stage

countries including the UK, Germany

from claiming the 100 per cent Year

transfers involving bonds to be

and France have introduced new

1 write-offs on plant types deemed to

issued to investors by special

balance sheet taxes on banks. These

be environmentally favorable. Such a

purpose companies, FTT could be

taxes all follow a similar form,

concession for business cars with

triggered on every transaction in the

although they have not been co-

very low carbon emissions was

process. This would give rise to an

ordinated through the EU. They serve

available to lessors until March this

imposition far above the nominal rate

in effect as a tax on wholesale

year, but has now been removed. UK

of the tax.

funding by banks, since the tax base

than lessors can claim CAs. Also, lessors have been excluded

asset finance agreements can be

The Commission issued a draft

comprises the total balance sheet,

structured with bargain purchase

outline of the FTT earlier this year.

less retail deposits and shareholders'

options or as conditional sale

Under this proposal, FTT would be

capital.

contracts (i.e. with no RVs), in which

charged on:

that may be available. However, this

These taxes have no specific effects on asset finance, but they

case the lessee can claim any CAs - any relevant trade executed within

form part of the overall fiscal

is obviously of limited value where

a tax charging country, or by a

environment for banking sector

the lessee/ hirer is not in a position to

financial institution based in such a

lessors. They tend to discourage

country;

international banking groups from

make timely use of the allowances.

- in addition, on trades executed FTT Eleven EU member states including

elsewhere in certain defined

charging countries, as they are

instruments issued in a charging

applied by each country to the global

country.

assets of locally based banks, but only to the local banking assets of

Germany, France and Italy are jointly developing a financial transactions

basing themselves in the tax

The second leg of the proposed

foreign based banks. In the UK the main corporation tax

tax (FTT), designed to charge tax at a

tax – affecting external trades in

rate of 0.1 per cent on the trading of

locally issued instruments - is

rate is being reduced progressively

financial instruments. This would not

modelled on the existing UK stamp

to an internationally competitive rate

apply to primary credit advances

duty on purchases of company

of 20 per cent. However, the bank

such as leases. However, it would

shares. However, it would apply to a

levy rate has been subject to

affect the secondary funding of

wider range of instruments than

continual increases at the same time,

leases.

shares, including bonds and

so as to cancel out the benefit of

exchange-traded derivatives.

reduced corporation tax to the

These countries are proceeding under the EU's “enhanced co-

The UK authorities are now

operation” procedure, which allows

considering a legal challenge in the

member states to co-ordinate certain

European Court of Justice (ECJ)

actions in conditions where there is

against the current Commission

no EU-wide agreement. The

proposal, because of its effects on

European Commission takes the

trades executed outside the charging

initiative in drafting the ground rules.

countries. It remains to be seen

The FTT was moved into the

whether this matter will proceed to a

enhanced co-operation arena after

hearing by the ECJ, or will be

an earlier proposal for FTT

resolved through negotiations

throughout the EU met with

between the UK and the Commission

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banking sector.

Asset finance - legal and regulatory update KEY ASSET FINANCE REGULATION 2012-2013

Key developments over the past year Date

Subject area

New development

Taxation

Reduction in rates of UK annual write-offs of expenditure on

2012 April

equipment (for allowances claimed from this date): main rate down from 20% to 18%, rate for long life assets down from 10% to 8%. April

Accounting

International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB) announce further slippage in timetable for finalization of new leasing standard, following earlier disagreement between them on profit and loss (P&L) account expensing rules for lessees.

April-May

Accounting

Outreach exercise with lessees, lessors and account users shows no support for IASB's preferred model for lessee expensing

June

Banking supervision

US authorities issue Notice of Proposed Rule-making (NPR) for implementation of Basel III changes (to be applied to “core” and “opt-in” banks)

June

Banking supervision

EU agrees in principle for “banking union” proposal within Euro zone, including some transfer of banking supervision powers to European Central Bank (ECB)

June

Accounting

Boards reach agreement on new proposal for P&L accounting, based on equipment v real estate split: most equipment lessees to apply front loaded profile; confirmation of “receivable and residual” (R&R) model for equipment lessors.

June

Banking supervision

UK government firms up legislative proposals for capital “ring fencing” of UK retail banking within major banking groups, and longer term proposals requiring banks to issue more lossabsorbing debt

June

Banking supervision

Start of temporary increase to minimum capital requirements for all banks in EU, pending transition to Basel III rules due from 2013

July

Taxation

Financial transactions tax (FTT) formally abandoned as EUwide proposal; but several member states including France and Germany agree to pursue possible co-ordinated adoption of the tax under “enhanced co-operation” procedure.

July

Accounting

Boards' new proposals for lessee expensing criticized by US account users represented on FASB's Investors Technical Advisory Committee (ITAC)

July

Banking supervision

European Banking Authority (EBA) announces that EU common supervision in line with phased Basel III rules will be delayed beyond January 2013 due to delay to agreement on associated European legislation

August

Lease funding

Start of UK Funding for Lending (FFL) scheme: central bank funding of commercial bank credit, including some leasing business

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Asset finance - legal and regulatory update KEY ASSET FINANCE REGULATION 2012-2013

September

Accounting

Boards complete main re-deliberation process on technical issues arising from June decision on split lessee expensing model

October

Banking supervision

Basel Committee of Banking Supervisors (BCBS) finalizes rules for required national action for enhanced regulatory capital buffers for “domestic systemically important banks” (D-SIBs) following earlier decisions for “global systemically important banks” (G-SIBs)

October

Banking supervision

Liikanen Report proposes EU-wide rules for capital ringfencing of retail banking within universal banks

November

Lease funding

IOSCO (international securities market regulatory body) proposes global convergence of rules for minimum risk retention by credit originators in securitizations

November

Banking supervision

Financial Stability Board (FSB) identifies individual banks to be treated as G-SIBs under Basel III

November

Banking supervision

FSB issues consultative proposals on global regulation of “shadow banking”

December

Banking supervision

EU reaches agreement on move for ECB to assume supervision of the larger banks within Euro zone states

December

Accounting

UK and German national standard setting bodies criticize IASB/ FASB proposals, and call for more cost-benefit analysis

Date or period

Subject area

Development

Banking supervision

General start of transition to global Basel III rules (subject to

2013 January

implementation delays in many jurisdictions): - 1st of 3 annual phases of higher common equity tier 1 (CET 1) capital levels - removal of newly disqualified capital instruments from CET 1 capital - 1st of 10 annual phases in removal of other capital instruments to be newly disqualified from non-CET 1 capital. January

Taxation

Ending of US fiscal stimulus for investment in equipment (enhanced Year 1 write-offs): rates revert to pre-stimulus levels for each asset class, for expenditure incurred from this date.

January

Taxation

January

Banking supervision

Further increase in rate of UK bank levy BCBS agrees major relaxation of earlier agreement for Basel III liquidity rules due for adoption from 2015

January

Business conduct

UK government confirms plans to transfer Consumer Credit Act regulation from Office of Fair Trading (OFT) to the new Financial Conduct Authority (FCA); but with further consultation on some aspects.

January

Taxation

European Commission firms up proposals for FTT among 11 concurring member states under enhanced co-operation procedures

February

Banking supervision

EU institutions reach agreement on principles of legislation to implement Basel III changes

March

Taxation

UK Budget statement: government announces further future reduction in corporation tax rate, but future rise in bank levy rate

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Asset finance - legal and regulatory update FUTURE ASSET FINANCE REGULATION 2013

March

Taxation

Ending of lessors' access to enhanced tax write-offs on “green” car fleets in UK, for expenditure incurred after this month

March

Banking supervision

Commencement of Basel III implementation in Japan

April

Taxation

UK main corporation tax rate falls from 24% to 23%

April

Banking supervision

UK oversight passed from former Financial Services Authority (FSA) to Prudential Regulation Authority (PRA) within Bank of England

April

Taxation

Start of optional “cash basis” for UK income tax on unincorporated micro-businesses: simplified tax deductibility of rentals etc for eligible lessees.

April

Accounting

FASB votes narrowly to confirm concurrence with proposals agreed to date with IASB: some members indicate that they will attach dissenting notes to new exposure draft.

April

Taxation

April

Lease accounting

UK launches legal challenge against European Commission's FTT proposals Extension of UK FFL scheme to include bank lending to nonbank lessors

Timetable for future developments Likely date or period

Subject area

Development

2013 May-June

Banking supervision

US authorities likely to finalize Basel III compliance rules for affected banks

May-June *

Lease funding

US authorities to announce next step (either finalization or further consultations) on minimum risk retention rules for securitization deals

May-July*

Banking supervision

BCBS to receive report on consistency of regulatory risk asset weightings on credit exposures

May

Accounting

Second exposure draft (ED2) of new standard to be issued by joint Boards

May-June

Accounting

June-July

Accounting

July-August

Taxation

Boards to consult with US lessees, lessors and account users on ED2 P&L account proposals National standard setting bodies outside USA likely to comment on ED2 “General anti-abuse rule”, giving UK tax authorities additional powers to counteract artificial avoidance, to take effect on final passage of 2013 Finance Act

September

Accounting

October

Accounting

Expiry of comment period on ED2 Boards to commence re-deliberation of accounting standard following comments on ED2

November

Taxation

Target date for report from Swedish review of corporate taxation

November

Business conduct

Possible date for FCA to issue details of proposed rules for UK credit business regime to take effect from April 2014

December

Accounting

Earliest likely date for Boards to issue final version of new standard

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Asset finance - legal and regulatory update FUTURE ASSET FINANCE REGULATION 2014-2015

Likely date or period

Subject area

Development

January

Banking supervision

January

Banking supervision

January January onwards

Taxation Taxation

January onwards

Accounting

March

Banking supervision

April April

Business conduct Taxation

Further transition steps in Basel III: - next phases in increased CET 1 capital ratios and removal of certain instruments from non-CET 1 capital; - 1st of 5 annual phases in required new deductions from capital (for goodwill etc). Effective start date for compliance with Basel III (first two phases) in EU Further increase in UK bank levy rate Authorities in many counties (including the UK) subject to international financial reporting standards (IFRS) will start to review the corporate tax treatment of some features of leasing transactions, as a consequential effect of the new accounting standard (if finalized) Possible start of moves by national standard setters to align national GAAP lease accounting rules for unlisted companies with the new global standard (if finalized), in EU countries where national GAAPs are currently close to, but independent from, IFRS – including UK, Sweden, Netherlands and Norway. Effective date for ECB to assume partial control of banking supervision in Euro zone UK credit regulation to pass from OFT to FCA UK corporation tax rate to fall to 21%

Likely date or period

Subject area

Development

January

Banking supervision

January

Accounting

January

Lease funding

January

Banking supervision

April May

Taxation Banking supervision

Further transition steps in Basel III: - 1st of 5 annual phases of new liquidity coverage ratio (LCR); - final phase of higher CET 1 capital requirements; - next phases of removal of certain instruments from non-CET 1 capital, and items to be deducted from capital. Likely “date of initial application” (DIA), for purposes of prior year accounts comparable with period after final effective date of new lease accounting standard, for US listed companies Minimum 5% risk retention rule for securitizations in which EU banks invest (in force since January 2011 for new bond issues) to be extended to new exposures within pre-2011 securities Risk asset weightings for US non-core banks to become more aligned with Basel II model UK corporation tax rate to fall to 20% Final target date for UK legislative enactment of “ring fencing” rules for separate capitalization of retail banking operations within major banks

2014

2015

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Likely date or period

Subject area

Development

2016 January

Banking supervision

Further transition steps in Basel III: - 1st of 4 annual phases in start of new “buffer zones” (i.e. levels of CET 1 capital above minimum for licensing, but within which banks will be subject to limits on distributions from profit), and in capital surcharges for G-SIBs; - next phases of removal of certain instruments from non-CET 1 capital, items to be deducted from capital and LCR - start of capital surcharges for D-SIBs.

January

Accounting

Likely DIA (see above) for new standard for listed companies subject to IFRS, and for US unlisted companies

Likely date or period

Subject area

Development

Banking supervision

Further transition steps to Basel III: next phases of buffer

2017 January

zones, G-SIB surcharges, removal of certain instruments from non-CET 1 capital, items to be deducted from capital, and LCR. January

Accounting

Likely final effective date of new global standard (except for companies eligible to use the international standard for smaller companies (IFRS SMEs))

Likely date or period

Subject area

Development

2018 January

Banking supervision

Further transition steps in Basel III: - (subject to further review) introduction of “net stable funding ratio” (additional liquidity rule); - introduction of new leverage ratio (regulatory capital measured against unweighted risk assets); - final phase of items deducted from capital; - next phases of buffer zones, G-SIB surcharges and removal of certain instruments from non-CET 1 capital.

January

Accounting

Likely final effective date of new global standard for users of IFRS SMEs

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Asset finance - legal and regulatory update FUTURE ASSET FINANCE REGULATION 2019-2022

Likely date or period

Subject area

Development

Banking supervision

Further transition steps to Basel III:

2019 January

- final phases of buffer zones, G-SIB surcharges and LCR; - next phase of removal of certain instruments from non-CET 1 capital. January

Banking supervision

Target effective date for required use of more loss-absorbing debt by UK banks

Likely date or period

Subject area

Development

2020-2022 January each year

Banking supervision

Final transition to Basel III, with last 3 phases of removal of certain instruments from non-CET 1 capital,

* = best estimate of uncertain date,

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