pwc real estate leasing* *connectedthinking. slide 2 19 october 2005 real estate leasing...

Real Estate Leasing*Real Estate Leasing*

*connectedthinking

October 2005

Real Estate LeasingPricewaterhouseCoopers

Content

1. Accounting

Dan Marinescu, Senior Tax Consultant PricewaterhouseCoopers

2. Tax

Richard Grotendorst, Tax Manager PricewaterhouseCoopers

3. VAT

Diana Coroaba, VAT Manager, PricewaterhouseCoopers

Real Estate Leasing* Real Estate Leasing* AccountingAccounting

*connectedthinking

Dan Marinescu – Senior Tax ConsultantDan Marinescu – Senior Tax Consultant

October 2005


Operating Lessor Accounting

Rental Income

Recognise on straight-line basis over the lease term

Unless some other systematic basis is more representative of the time pattern in which the benefit derived from the leased asset is diminished

Costs

Costs, including depreciation, incurred in earning the lease income are recognised as expenses

Depreciation allocated on a systematic basis consistent with the lessor's policy for similar assets

Initial direct costs (e.g. legal fees) on an operating lease

Defer or Recognise

October 2005


Operating Lessee Accounting

Rental expenses

Recognise on straight-line basis over the lease term

Unless some other systematic basis is more representative of the time pattern of the lessee’s benefit

Costs

Costs for services, maintenance and insurance are recognised as expense when incurred

Investment property under IAS 40

A real estate property interest held under operating lease can be classified as investment property

Property interest is accounted for as finance lease

The fair value model must be adopted

Provided the Real Estate property is held for capital appreciation or to earn lease rentals

October 2005


Finance LesseeAccounting

Recognises the asset and the lease obligation on balance sheet

at the lower of the present value of the minimum lease payments (MLP) and the fair value of the asset

Use interest rate implicit in the lease if this is practicable to determine; if not, use lessee’s incremental borrowing rate

Initial direct costs incurred by the lessee in securing the lease (e.g. commission and legal fees) are included as part of the recognised asset

October 2005


Finance Lessor Accounting

Fixed Asset Receivable

= MLPs from the lessor’s point of view

+ unguaranteed residual

– unearned finance income

Net investment in the lease

Gross investment in the lease

October 2005


Summary

Balance Sheet Income Statement

Finance Lease - Lessee Asset

Lease Obligation

Accumulated Depreciation

Reduction in Lease Obligation

Finance Charge

Depreciation Expense

Finance Lease –Lessor Receivable

Reduction in Receivable

Finance Income

Profit/Loss on Sale

Operating Lease -Lessee N/A Rental Expense

Operating Lease - Lessor Asset

Accumulated Depreciation

Rental Income

Depreciation Expense

October 2005


Leases involving land and buildings

Need to consider land and buildings individually

Land in principal operating lease (unless title passes)

Buildings decide whether finance or operating lease

Under IAS 17

MLP allocated between Land & Buildings (L&B)

(Separate measurement is not required if land is immaterial or lessee’s interest in

L&B are classified as an investment property)

October 2005


Complex issues

Subleases

Sale and leaseback

Linked transactions

Lease and leaseback

Leases between related parties

Sale and leaseback with special purpose entities

October 2005


Sale and Leaseback

Sale of Real Estate by the vendor followed by leasing of the same asset to the vendor

Finance Lease Operating Lease

Sales proceeds 100

Carrying amount (80)

20

Defer and amortise over lease term

Sale price = FV

Recognise any profit or loss immediately

Sale price > FV

Defer and amortise excess over period of asset use

Sale price < FV

Recognise profit or loss immediately

If loss compensated by lower future lease payments at below market price defer and amortise it in proportion to the lease payments

October 2005


Linked transactions

Leases between related parties

True economic substance of the transaction prevails over the legal form

Transactions frequently not conducted at arms length terms criteria for an operating leaseback may not be met

Lease and leaseback

Lease accounting based on the substance of risks and rewards

Up-front lease payment followed by leaseback for shorter periods with annual rental payments

Option to extend the lease

Finance arrangement

October 2005


Sale and lease back with special purpose entities

Involves the transfer and leaseback of an asset by the seller, to a special purpose entity (lessor) wholly or partly funded by bank borrowings or debt securities

Accounting treatment of such transactions is complex

Seller could de-recognise the asset unless control substantially all the risks and rewards of the asset

Real Estate Leasing* Real Estate Leasing* TaxationTaxation

Richard GrotendorstRichard Grotendorst - Tax Manager - Tax Manager

*connectedthinking

October 2005


Definition under Fiscal Code

Finance lease Art. 7 (7) FC

A lease whereby at least one of the following conditions is met:

The risks and benefits of the ownership of the leased property are transferred to the lessee upon inception of the leasing contract.

The leasing contract expressly provides for the transfer of ownership of the goods subject to leasing to the user upon expiry of the contract.

The leasing term covers at least 75% of the useful life of the leased property (including any extensions of the lease term).

Operating lease Art. 7 (8) FC

Any leasing contract that does not fulfill the conditions to be classified as a finance leasing.

October 2005


Fiscal Aspects

Financial lease

The asset is depreciated by the lessee.

The interest expenses are deducted by the lessee.

The building/land taxes are paid by the lessor.

Insurance premiums are paid as agreed between the lessor and the lessee.

Fx gains (losses ) are taxable (deductible).

Operating lease

The asset is depreciated by the lessor.

The lessee deducts the lease instalments.

The building/land taxes are paid by the lessor.

Insurance premiums paid as agreed between the lessor and the lessee.

October 2005


Interest deductibility

Two deductibility criteria:

1. Limitation of interest expense

Loans from non-financial institutions (e.g. group companies)

Limits: - NBR reference interest rate (RON)

- 7% (foreign currency)

Non-deductible interest cannot be carried forward

2. Thin capitalisation rules (debt to equity 3:1)

Interest and foreign exchange differences (debts > 1 year)

Non-deductible interest can be carried forward

! The criteria are not applicable to leasing companies (leasing operations only) and to finance leases

October 2005


Tax Depreciation (1)

finance leasing - lessee is the owner

Depreciation of the asset at the level of the lessee

operating leasing - lessor is the owner of the leased asset

Depreciation of the asset at the level of the lessor

! The general depreciation rules apply for leasing operations

October 2005


Tax Depreciation (2)

Difference between accounting and tax depreciation

Based on useful lives stated in the Catalogue of Fixed Assets:

Buildings (40 – 60 years), technical equipment (commonly 5 - 20 years), office equipment (2 - 6 years)

Land is not depreciable, but costs for land modernisation depreciable (10 years).

Depreciation methods: straight-line (buildings), accelerated, reducing balance

Complex assets (e.g. buildings) may be depreciated by subcomponents

Valuation report by an independent appraiser recommended

For assets acquired after having been partially utilised, useful life could be determined by technical experts

Revaluations are not recognised for fiscal purposes after 1 January 2004

October 2005


Leases vs. Rental

Rental contracts have similar profit tax treatment as operating leases

Financing costs are fully tax deductible under leases as no thin capitalisation rules apply and there are no other limitations

Limitation of tax deductibility of financing costs for pure rental operations financed by loans granted by other entities (either group companies or not) or shareholder’s loans based

No option right of tenant to purchase the real estate or minimum value of rented property required as opposed to leases

The rental period could be less than one year while the period of the lease contracts exceeds one year

No authorisation or computation method are required for rental agreements

October 2005


Other tax issues

Cross-border leasing – Non-resident owners of Romanian Real Estate

Real Estate leased to residents and Permanent Establishment’s of non-residents

Real Estate leased to non-residents

Potential WHT implications

Local taxes – payable by the owner of the leased asset

Land tax – fixed amount per sqm depending on the location

Building tax - 0.5% to 1% of the building’s value or, if not revalued, between 5-10%

October 2005


Potential legislative amendments?

Fiscal Code

Specific provisions as regards Real Estate leasing (operating vs. finance lease)

Tax depreciation of Real Estate investments.

Tax incentives (investment allowance, re-investment reserve).

Law 332/2001 on direct investments with significant impact on the economy

Real Estate leasing to be included.

GO 51/1997 on leasing operations

Define sub-lease.

Establishes a regulatory body on the leasing market.

Real Estate Leasing* Real Estate Leasing* VATVAT

Diana CoroabDiana Coroabaa - VAT Manager - VAT Manager

*connectedthinking

October 2005


Leasing-Real Estate

Current treatment

Subject to VAT

EU Accession

Exempt with option to tax

Option to tax the leasing

=> Mandatory taxation of any subsequent transaction (?!)

October 2005


Financial leasing

Current treatment

VAT on principal

Interest not subject to VAT

EU Accession

Option to tax

VAT on installments

(principal + interest)

October 2005


Adjustment period

Twenty years starting:

from 1 January of the year during which the right to deduct arises, for the construction, purchase, transformation (20%) or improvement (20%) of a building

from 1 January of the year during which the building was first used

October 2005


Adjustment method

The adjustment is made once only for the whole period of adjustment still to be covered

The adjustment should be performed on an yearly basis in case the destination of the building is changed from taxable to exempt operations or vice-versa

October 2005


Examples of Examples of one - off adjustmentone - off adjustment - 20 years - - 20 years -

October 2005


A leasing company purchases a building on 15 December 2007 for the price of 7.140 RON incl. VAT (19% = 1.140 RON). It deducts 1.140 RON. It uses the building for operations with a right to deduct.On 2 February 2009, the company concludes a leasing contract for the building. It does not opt to tax the operation and therefore the leasing will be exempt without a right to deduct.

Solution

Year 1 (2007) is taken into consideration

Year 2 (2008) is taken into consideration

The loss of the right to deduct VAT appears in year 3 (not taken into consideration)

Adjustment in favour of the State: 1.140 RON x 18/20th = 1026 RON to be paid

Example 1

October 2005


Example 2

A leasing company purchases a building in 2007 for the price of 11.900 RON incl. VAT (19% = 1.900 RON). It knows it will use the building for exempt operations (i.e. leasing) and does not deduct the input VAT. The company concludes a leasing contract for the building for 5 years starting with 2007 and does not opt for taxation.

In 2012, the leasing company concludes a new leasing contract with another beneficiary for the next 15 years.

October 2005


Solution

In 2007 the company is not entitled to deduct the input VAT

In 2012 the company leases the building and opts to tax the leasing => The company must adjust the initial input VAT

The right to deduct VAT appears in year 5 (not taken into consideration)

Adjustment in favour of the Company: 1.900 RON x 16/20th = 1.520 RON

Example 2

October 2005


Example 3

A leasing company purchases a building in 2007 for the price of 11.900 RON incl. VAT (19% = 1.900 RON). It knows it will use the building for exempt operations (i.e. leasing) and does not deduct the input VAT. The company concludes a leasing contract for the building for 8 years starting with 2007 and does not opt for taxation.

In 2015, the leasing contract expires and the leasing company decides to sell the building and tax the transaction. The sell price will be, due to unfavourable market conditions, 5.950 RON incl. VAT (19% = 950).

October 2005


Solution

In 2007 the company does not deduct the input VAT

In 2015 the company sells the building and opts to tax the transaction => The company must adjust the initial input VAT

The right to deduct VAT appears in year 9 (not taken into consideration)

Adjustment in favour of the Company: 1.900 RON x 12/20th = 1.140 RON , however the deduction is limited to 5.000 x 19% = 950 RON ( the output VAT charged on sale)

Example 3

October 2005


Compliance

Main requirements:

The taxable person must keep a list of the capital goods subject to VAT adjustment allowing the control of all tax deducted and adjustments made

This list must be kept during a period of five years after the end of the adjustment

Any other records, documents and books relative to capital goods must be kept during the same period

October 2005


In addition:

More information will be included in the VAT return

No longer – standard sales & purchase ledgers

Quarterly recapitulative statements for intra-Community deliveries and acquisitions

October 2005


Possible case scenarios after AccessionPossible case scenarios after Accession

October 2005


2 operations:

Leasing – service: Taxable (option)

VAT on each installment (principal and interest)

No input VAT adjustment

Local supply of immovable goods at the end of the leasing contract (if option exercised): Mandatory taxation (?!)

VAT on the sale price

ROMANIANLEASING

COMPANY

ROMANIAN CLIENT

Leasing with option to tax

Delivery of goods

October 2005


Leasing – service: VAT exempt

Leasing company must adjust the input VAT initially deducted in relation to the building, if any

One – off adjustment method

ROMANIANLEASING

COMPANY

ROMANIAN CLIENT

Leasing without option to tax

October 2005


Foreign leasing company pays Romanian VAT on acquisition if the immovable property is a new building

Leasing – service: VAT exempt

Foreign leasing company does not have to register for VAT purposes in Romania

FOREIGNLEASING

COMPANY

ROMANIAN CLIENT

Leasing without option to tax

Romanian supplier

Acquisition of new building

(VAT)

October 2005


Foreign leasing company pays Romanian VAT on acquisition if the immovable property is a new building or if the supplier opts to tax the transaction

Leasing – service:

Taxable

Romanian VAT on each installment (principal and interest)

Foreign leasing company has to register for VAT purposes in Romania and is entitled to deduct the input VAT on acquisition

FOREIGNLEASING

COMPANY

ROMANIAN CLIENT

Leasing with option to tax

Romanian supplier

Acquisition of immovable property

(Exempt with option to tax)

October 2005


PricewaterhouseCoopers services

Training

Pre-accession review (included tailored training)

Pre-accession Forum

October 2005


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© 2005 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers.

pwc real estate leasing* *connectedthinking. slide 2 19 october 2005 real estate leasing...

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