Even before the economic climate was severely damaged by the coronavirus pandemic, commercial tenants were struggling to meet their rent obligations. Drastic falls in demand and footfall in shops during the pandemic have heaped further strain on profits and cash flow, which may lead tenants and their landlords to agree to alternative arrangements such as:
- a rent holiday;
- a rent deferral (including any interest to be accrued on the amount deferred);
- a write off for an agreed period (including any accrued unpaid rent);
- a reduction in service charges;
- changing the terms of the lease (moving to a turnover rent base either on a temporary or permanent basis, or a rent reduction); or
- terminating or breaking the lease.
Any arrangement will have accounting and tax implications and, while this may not be at the forefront of a tenant’s or landlord’s mind at a time of crisis, they will need to be considered further.
Coronavirus-related rent concessions, such as rent holidays and temporary rent reductions, are not expected to impact significantly the determination of accounting and tax positions of landlords outside of existing guidance.
However, the determination of tax positions for the tenants/lessees will follow the accounting treatment of any such rent concessions, rent holidays and temporary rent reductions, which will be influenced by a number of factors:
IFRS reporters who are finding themselves implementing or having recently implemented IFRS 16 Leases will be able to apply the recent IASB amendment, which exempts, subject to certain conditions, lessees from having to consider individual lease contracts to determine whether rent concessions occurring as a direct consequence of the coronavirus pandemic are lease modifications and allows lessees to account for such rent concessions as if they were not lease modifications. The amendment applies to coronavirus-related rent concessions that reduce lease payments due on or before 30 June 2021 and is effective 1 June 2020 but, to ensure the relief is available when needed most, lessees can apply the amendment immediately in any financial statements - interim or annual - not yet authorised for issue.
Provided revised lease payments do not in substance lead to an increase in the overall lease liability to the lessee and the change can be solely attributed to the effect of the coronavirus pandemic, lessees applying the exemption will be expected to recognise a gain in the profit or loss account arising from the derecognition of the lease liability triggered by rent concessions.
In the alternative where rent concessions are assessed as lease modifications, the lessee will remeasure the original lease by discounting the revised lease payments using a revised discount rate at the modification date, make a corresponding adjustment to the right-of-use asset and recognise a gain in profit or loss if the adjustment is higher than the carrying value of the right-of-use assets.
Assuming a lease agreement has not become onerous, UK GAAP reporters will also need to consider the most appropriate treatment of any modifications made to a lease agreement as a result of coronavirus, including the ability to utilise ‘another systematic basis’ if that is more representative of the entity’s use of the asset.
An example of ‘another systematic basis’ is if a landlord agrees to a suspension of the lease for three months as a result of coronavirus (so the term is extended by three months, and a three month rent free period is granted), meaning that the entity is not able to access their office for those same three months, it may be appropriate to recognise no rental costs. This is different to the usual treatment of rent-free periods where cost would be accrued to facilitate spreading the costs evenly over the entire term of the agreement. Other changes to lease arrangements may have different accounting treatments and each one should be considered on its own merits.
Tax points to consider:
- Any gain arising on the re-measurement reflects the (taxable) refund of rentals that have been allowed as an expense in the earlier periods and would need to be brought into account for tax purposes.
- Care needs to be taken on any arrangement which may result in a variation of the lease. A lease variation would have unintended consequences from a tax perspective in that the variation would result in a deemed surrender and regrant of the lease from a stamp duty land tax (SDLT) perspective.
- Parties will need to consider the potential SDLT/VAT implications of the agreed arrangements. For example, if a landlord has agreed for a rent holiday in return for removing a break clause, there should be no SDLT charge (as giving up a right is not consideration for money).
- Whether payments are being made to landlords to terminate the lease as there are options on how to structure this to make it more tax efficient for both parties (e.g. dilapidation payments).
- Consider the impact of the changes on corporate interest restrictions (CIR) calculations. For example, if the arrangement results in a reduction in the finance charges for ‘standard’ operating leases for tenants, this should improve the tax EBITDA (as in this case, the finance charge is not ‘interest’ for CIR purposes) but may have an impact on group ratio calculation.
- Interaction with transitional arrangements arising on implementing IFRS 16.
- Deferred tax provisioning: there may be differences in the accounting treatment where the group accounts are prepared under IFRS but the individual entities are prepared under FRS102.
The accounting and tax determinations are fact-specific so we recommend that advice is obtained to evaluate the implications of any agreed coronavirus-related rent concessions such as rent holidays and temporary rent reductions.