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Caveat:
- Please note that as at the time of writing this post, FIRS has not officially issued clarification on the tax implications of IFRS 16. Nonetheless, this post has been written in line with extant tax laws.
- In addition, the general idea of this post is based on FIRS Information Circular 2010/01 – Guidelines on the tax implication of leases. This information circular is based on IAS 17, which has now been replaced by IFRS 16.
- Sections of the tax law referenced in this post are subject to verification as subsequent Finance Acts may alter the tax law. However, updates will be made regularly as appropriate.
- You may want to refresh your knowledge of IFRS 16 before you continue. For this reason, you should check out the simplified version of IFRS 16. Otherwise, you may proceed😊.
Let's now explore the tax treatment for lessors under IFRS 16 in Nigeria.
IFRS 16 primarily impacts lessees, but for lessors, the accounting treatment remains largely similar to IAS 17. Lessors still classify leases as either finance leases or operating leases, and each classification has distinct tax implications. Drawing from the FIRS guidelines, here's the tax treatment for lessors in Nigeria:
1. Finance Lease:
Under a finance lease, the lessor transfers substantially all the risks and rewards of ownership of the asset to the lessee. The asset is treated as sold by the lessor and recognized as a receivable.
Tax Implications for Lessors:
i) Companies Income Tax (CIT):
- Interest income: The lessor earns interest on the finance lease. This interest income is taxable in the hands of the lessor as part of its gross income.
- Principal repayment: The capital portion of the lease receivable (the repayment of the asset's value) is treated as a recovery of the lessor’s investment in the asset and does not have tax implications, as it is a return of capital.
- Capital allowances: Under a finance lease, the lessor does not claim capital allowances on the leased asset. The asset is effectively "sold" to the lessee, who assumes the right to claim capital allowances. If the lessor claims capital allowance, FIRS will disallow it.
ii) Withholding Tax (WHT):
- WHT on interest: Withholding tax applies only to the interest portion of the lease payments. The lessee is required to withhold tax at the prevailing rate (usually 10%) on the interest paid to the lessor in line with Section 78 of CITA. The lessor will receive the net lease payment after WHT. Upon remitting the WHT amount by the lessee to FIRS, the WHT will automatically reflect on the TaxPro Max page of the lessor and can be used to offset the lessor's income tax liabilities.
iii) Value Added Tax (VAT):
- VAT on interest: Under a finance lease, the interest income earned by the lessor is treated as a return on investment (ROI) and is not subject to VAT. This is in line with Section 2(1) of the value Added tax Act {VATA} which states that VAT applies to the supply of goods and services except those specifically exempted in the First Schedule to VATA. By implication, since ROI is not considered a supply of goods or services, it is not subject to VAT.
iv) Capital Gains Tax (CGT):
- CGT on asset disposal: If the lessor disposes of the leased asset at the end of the lease period (or earlier), any capital gain realized from the sale of the asset would be subject to Capital Gains Tax (CGT) at 10% in line with Section 2 of the Capital Gains tax Act (CGTA). The CGT would be computed on the difference between the sale price and the tax-written-down value (TWDV) of the asset.
2. Operating Lease:
In an operating lease, the lessor retains significant risks and rewards of ownership. The asset remains on the lessor’s balance sheet, and the lessor records rental income over the lease term.
Tax Implications for Lessors:
i) Companies Income Tax (CIT):
- Rental income: The total lease rental income earned by the lessor under an operating lease is fully taxable. It is treated as business income for CIT purposes. The entire lease payment is included in the lessor's taxable income in line with Section 9 of CITA.
- Capital allowances: Since the lessor retains ownership of the asset, the lessor is entitled to claim capital allowances on the leased asset.
ii) Withholding Tax (WHT):
- WHT on rental payments: The lessee is required to withhold tax at the rate of 10% from the total lease rental paid to the lessor in line with Section 79 of CITA. The WHT applies to the entire rental amount, not just the interest portion, as the lessor is receiving rental income rather than financing income. The lessor can offset this WHT against its income tax liability.
iii) Value Added Tax (VAT):
- VAT on lease rental: Under operating lease, the lease rental income is subject to VAT at 7.5% in Nigeria (Section 4 of VATA). The lessor is required to include VAT on its invoice to the lessee, and the lessee must pay the VAT alongside the lease rental. The lessor will account for the VAT received and remit it to FIRS, while the lessee may claim the VAT as input tax, provided the leased asset is used for VATable supplies.
- In view of the point above, please note: Interest in land and building in the form of rent or lease (commercial or private) is specifically exempt from VAT. In addition, hire, rental or lease of tractors, ploughs and other agricultural equipment for agricultural purposes is also exempt in line with the FIRS schedule to VATA.
iv) Capital Gains Tax (CGT):
- No CGT unless asset is sold: There is no immediate CGT liability for the lessor during the lease term unless the lessor sells the asset. If the lessor sells the leased asset at the end of the lease, any capital gain realized from the disposal would be subject to CGT. The gain would be the difference between the sale proceeds and the TWDV of the asset.
Key Points Summary:
1. Finance Lease (Lessors):
- Interest income is taxable under CIT.
- Capital portion of lease payments is a return of capital and is not taxable.
- Capital allowances are not claimable by the lessor; only the lessee can claim them.
- Withholding tax applies to the interest portion.
- No VAT on interest income.
- Capital Gains Tax applies if the leased asset is sold after the lease.
2. Operating Lease (Lessors):
- Rental income is fully taxable under CIT.
- Capital allowances are claimable by the lessor.
- Withholding tax applies to the full rental payment.
- VAT is chargeable on lease rentals.
- Capital Gains Tax applies if the leased asset is sold at a gain.