IFRS 16- Key changes and impact

Lease accounting is covered by IAS 17, but is being replaced by IFRS 16 which is effective for annual reporting period beginning on or after 1 January 2019. This post looks into the key changes in IFRS 16, as compared to IAS 17. There are several important changes in IFRS 16 compared to IAS 17, especially in relation to recognizing lease contracts in financial statement by the lessee.

Changes for the lessee

  1. Recognition of Lease assets

The current IAS 17 requires differentiation between operating lease and finance lease for the lessee. If the lease does not meet the criteria of finance lease, it is regarded as operating lease and does not form part of SOFP, and is treated as off balance sheet item. One of the major changes in IFRS 16 is that the lessee now follows a single accounting model and is required to recognize all leases with the term of more than 12 month in its financial statement, unless the underlying assets is of low value. So, the need for differentiation between finance leases and operating leases is now eliminated. As per IFRS 16, once lease contract is entered into, lessee is required to calculate the cost of right-of-use assets at cost, as per Para 24 of IFRS 16, and show the lease as lease assets (right-of-use assets). Similarly, lease liability is recognised at present value of the lease payments.

2. Depreciation and Interest for lease liabilities

In current IAS 17, the lease payments for operating leases are accounted as lease rental expenses and charged to income statement. But under IFRS 16, the nature of expense for lease would change. Once right-of-use assets are accounted in fair value as discussed above, the assets are depreciated using IAS 16 Property, Plant and Equipment, and interest expense should be recognized for lease liability. The interest component is calculated using effective interest rate method. Hence, under IFRS 16 the statement of comprehensive income will now have finance cost and depreciation on right of use assets, instead of the lease rental expense that is seen under IAS 17.

Investor perspective published by IFRS foundation (2016) reports that around 85% of the lease are off balance sheet item as per current IAS 17 because the leases do not meet the criteria of financial lease. Further, IFRS 16 Project Summary of IFRS foundation (2016) notes that listed companies using IFRS or US GAAP disclosed almost US$3 trillion of off balance sheet lease commitments in 2014 and so long-term liabilities of off balance sheet leases were understated from 22% to 45%, across continents.  This means for the off-balance sheet operating leases, only rent expenses are reported for those assets, and the investors had to adjust the figures to understand the actual financial position of the company.

The new changes would address this issue and provide more useful information to investors. All leases will now be accounted for and investors will know the value of lease contracts and associated liabilities and so also promotes transparency. When right to use assets and lease liabilities are recognized, the balance sheet size of the companies will be larger. This will have more impact on industries that is more dependent on leased assets. A global lease capitalization study conducted by PWC (2016) revealed that with the new standard the retailers would see median increase in debt of 98%, as compared to 22% for all companies. Changes in nature of lease expenses (Depreciation and interest instead of lease rental) and its accounting would have impact on the profitability of the company.

Changes for the lessor

IFRS 16 does not have much change for the lessor and the lessor continue to classify its leases as financial lease and operating lease. However, para 92 of IFRS 16 requires additional disclosure regarding the risk management strategy which did not exist in IAS 16. This means the lessor are encouraged to disclose how they manage their risk in the underlying lease assets

To conclude, IFRS 16 has some significant improvement over IAS 17, particularly the need to account for right-of-use assets and so is expected to improve the overall quality of financial disclosures in the financial statement with respect to leases accounting. The impact could differ between industries depending on extent of use of lease and those entities with significant leases will see distortion of key balance sheet and profitability ratio because of capitalization of all leases and change in nature of expenses.

Recovering tax from Teliasonera & Axiata deal- Steps forward

When I first wrote a blog on Ncell tax case last year, Nepal Government had just started discussing on if tax should be levied and what amount of tax should be collected from the deal. This blog analyses the position with respect to further and recent developments.

  • 8 May 2016- Ncell paid Rs. 9.96 billion as capital gain tax.  It was also reported that Ncell declared and paid tax under Sec. 57, Change in Control provisions of the law. Information relating to further assessment by tax office is not yet public and is expected to be in process.
  • 8 March 2017- The cabinet meeting decided that the capital gain tax is payable by Teliasonera (the seller) and not the buyer. . The finance minister reinforced this in his response to public accounts committee.
  • 14 March, 2017- The Office of Auditor General is said to have directed the Government to collect additional tax of Rs. 26 billion from NCell.

As I noted in my earlier posts, and  interview in Artha Sarokar TV program, our current legal provisions do not bring indirect tax into ambit of tax law, but the tax office have the right to disregard treaty benefit or corporate structures in case of sham entities, provided they are able to prove it using General Anti Avoidance Rules.

But after Ncell deposited Rs. 9.96 billion as Tax Deduction at Source, tax department is now relieved of the difficult task of establishing a sham entity, at least for 15% WHT. In other words, Ncell accepted that they have a withholding tax responsibility as per Sec. 95Ka of the Act with WHT rate being 15%. This in fact is suicidal for Ncell, and a decision taken on haste, without considering the legal consequences of accepting the liability, if the tax department moves further with WHT assessment.

So, for the WHT portion of 15% it is now irrelevant to discuss whether the transaction is taxable in Nepal or not.

What should the tax department do now?

As noted above, Ncell has accepted that they had a Withholding tax liability (WHT) as per the law. This means the tax department should take the following course:

  • To verify how selling price and cost price regarding the transaction have been calculated and whether the gain amount is correct as per Sec. 36 of the Act.
  • To check whether the cost price calculation can be substantiated with appropriate documentary evidences. The cost price can include:
  1. The cost of purchase of shares
  2. The cost of holding shares
  3. The cost of disposal of shares.
  • In case of Teliasonera, some or many of these expenses could have been expended out of Nepal, and documentary evidences might not be available with Ncell. As Ncell accepted the WHT responsibility, it is now for Ncell to provide the evidences to tax office.
  • In case of failure to provide adequate supporting, tax office can assess further WHT liability at the rate of 15% on each unsubstantiated expenses, plus interest on such WHT assessed.

What is the tax rate and who is liable to pay tax?

There is much debate around the tax rate for this gain and who is liable to pay it.

Ncell by its act of paying WHT has accepted the liability of 15% WHT on gain. We may consider the normal tax rate of 25%, but if tax office assesses tax additional to WHT (+10%), it will be a herculean task to really make Teliasonera to pay it. Teliasonera has repetitively denied any tax liability in Nepal, and acceptance of WHT by Ncell does not in any way make Telia liable for additional 10%. There is no legal base to assess NCell for the additional 10% liability, as instructed by Office of Auditor General. There are two issues to consider:

  • First tax office should be able to raise an assessment order to Teliasonera for this additional tax. There is a standard legal process for that to be followed. In addition, proving a sham entity, refuting the treaty benefit and making Teliasonera liable demands an extensive exercise.
  • Whether the existing legal provisions would be sufficient to bring a company with no existing set-up in Nepal can be dragged to Nepalese court is another issue to consider.

Teliasonera required approval of Nepalese government authority for sale of shares. That was the time when our authorities should have been proactive to discuss these tax aspects. Back in April 2016, within the IRD there was an internal report saying Teliasonera is liable to pay tax in Nepal. But we did not take action in time, and even today instead of tax authorities moving forward with re-assessment of WHT, the issue is being discussed in the cabinet and Public Accounts Committee.

On 16th March I had tweeted, “Supreme authority to interpret tax law is the court. Both Ncell & Government took a wrong path in Capital Gain Tax case & we are left with confusion & a mess”. Indeed. A tax practitioner like me would always wish that we levy tax within the purview of legal provisions, and the best authority to decide whether Teliasonera is liable to tax in Nepal would have been the Supreme Court. Lets hope we could see that someday.

At this hour, tax department should at least begin WHT assessment of Ncell by recalculating gain as per Sec. 36 because Ncell has already exposed itself to 15% WHT liability without any doubt.

Note to the readers: 

  1. The Income Tax Act does not use the word Capital Gain Tax, and so this term is used for general understanding only. As per law, the tax paid is income tax, but collected as deduction from source.
  2. It makes no difference whether we call WHT or Advance tax to refer to tax deposited by Ncell. It would still be regarded as advance income tax of Teliasonera.

Nepal Tax Online- Our new initiative

This month we launched our online Nepal Tax portal for subscription. It was a difficult journey, a concept that we started a year back, and still working further on it.

This is the first Nepal Tax portal with all the resources in income tax in one place, including legal cases (from Nepal & India), solutions to practical issues, public circular & rulings and tax laws of last five years.

The tax resource that we are building in the portal is unprecedented in Nepal and in the long run, this will be helpful for everyone- tax payers, auditors, advisors, INGO, businesses and even for students.  We are glad that we are receiving very good response to it, and will be continuing this work.

The interview below was taken by Artha Sarokar in its 51st episode, where I have explained the concept of Nepal tax online and how it benefits everyone. Further details are available on our website https://nepaltaxonline.com

What matters to me?

These days I often face question, weren’t you doing what mattered to you?

What matters to me? A question easy to ask, but difficult to answer. I have tried to response it in several instances, but I understand I haven’t been able to satisfy anyone with my answer. We cannot always satisfy other, and its being true to yourself that is essential. Still, the question remains. What is it that matters to me? Its the other way of saying, what is that which really drives me, or comes before anything else.  It was back in 2013 when I first pondered on this to draft into words & wrote the first version of this post.

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Auditing and Accounting challenges in Nepalese SME

Over the last several months, I got several opportunities to interact with small and medium tax payers and registered auditors, based in different districts of Nepal. We were working as resource person for a couple of assignments related with tax payer education program, a pilot project of GIZ RAS,  and capacity building initiatives of ICAN for registered auditors. Some of my observation relating to SME was published in my earlier blog post, “The Tax plights of micro SME.” Here I have tried to highlight two major issues on accounting and tax reporting, as reflected in our interactions.

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टेलियासोनेरा एनसेल शेयर बिक्रि प्रकरण- दफा ५७ र दफा ३५ के हुन् ?

टेलियासोनेराको एनसेल शेयर बिक्रि सम्बन्धमा मेरो विचार तल अन्त्यमा भएको अन्तर्वार्तामा  हेर्नु होला एवं अन्य व्यवस्थाहरुको विवेचना दुइ अन्य ब्लग पोस्टहरु मा समेत छ ।

यो पोस्टमा म दफा ५७ को बारे कानुनी व्यवस्था प्रकाश पार्ने प्रयास गर्नेछु । एनसेलको कर प्रकरणमा दफा ५७ प्रयोग गरेर कर उठाउन मिल्ने कुरो पटक पटक आइरहेको छ । तर के हो त दफा ५७?

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Nepal Income Tax Law- The need for improvement

Our tax law was promulgated in 2002 and was termed as modern compared to the earlier tax law we had and the last decade was a learning experience for the practitioners, the tax payers and the tax officers. Our current practice and issues faced show that the law is inadequate in several aspects, and perhaps its time for us to think on reforms needed for better tax practices.

Non-resident taxation- Individual

How many of the expats working in Nepal pay their employment tax here, especially when they are paid in their home country? How does tax office track the consulting income of expats who are paid abroad but give consulting services on tourist visa in Nepal?

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Minimum Audit Fees- Why increment is justified?

The Kantipur article   on audit fee begins with “Up to 10 times higher than the current fees.” The Supreme Court stay order in an appeal of a Cooperative has sparked a new debate on ICAN’s decision to increase fee to be charged by its members for audit and other services. Would 10 times high make sense if the initial base is low? Or is the recent fee increment by ICAN really so high that it can’t be justified?

The Supreme Court stay order is based on premise that determination of audit fee is the scope of AGM of the organization and ICAN, in absence of any specific legal provision, cannot limit right of an AGM. While it appears legally correct, the issue should be evaluated and judged considering other broader aspects of the issue.

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The tax plights of micro SME

“Last year one of the food retailers got a mismatch notice because someone declared bogus purchase from that retailer in his tax return. To justify its purchase, even bearer cheques were issued and cash withdrawn in name of food retailer.  The food retailer had to physically threaten the person to rectify his error to tax office.”

This was a case discussed in a SME Tax Training two weeks back organized in DCCI, Dhulikhel in association with IRD, GIZ and ICAN. The SMEs selected for the training had turnover less than Rs. 5 million (we call them micro SME here). Mismatch is a buzzword among the tax payers these days. Businesses of all types are facing the issue, but the small tax payers are facing its ruth more than others. Any mismatch arising from attempted tax evasion by the tax payer is justified, but not all mismatches are intentional or part of tax avoidance scheme. The case above is a classic example arising from mala fide intention of an unknown party affecting the micro SME. Such cases cannot be prevented by just having fair books of accounts and transparent tax payment. Further, micro SME with few million turnover, lack technical capacity and financial resources to maintain a robust accounting system or pay for an accountant or advisor. So, how does a micro SME protect itself from mismatch issues arising out of third party’s fault?

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