Tax Treatment of Right-of-Use (ROU) Asset for Lessees in Nigeria

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 This information circular is based on IAS 17, which has now been replaced by IFRS 16.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, dear reader, you may proceed😊 

Under IFRS 16, the accounting treatment of leases has significantly changed, especially for lessees. The key change is that lessees are now required to recognize a right-of-use (ROU) asset and a corresponding lease liability for nearly all leases on the balance sheet. This differs from IAS 17, where operating leases were off-balance-sheet items.

Given the FIRS guideline under IAS 17, we can derive how the tax treatment of ROU assets for lessees would likely work in Nigeria, considering the broader context of Nigerian tax laws and IFRS 16. Here's how:

1. Companies Income Tax (CIT) Treatment:

Under IFRS 16, lessees will recognize depreciation on the ROU asset and interest on the lease liability in their financial statements. However, for tax purposes, Nigeria's tax law is not IFRS-compliant by default, and adjustments are often necessary to align financial statements with tax regulations. Based on the principles in the FIRS guideline under IAS 17, here's how tax treatment for ROU assets could apply:

• Interest expense on the lease liability would likely remain tax-deductible. The FIRS guidelines under IAS 17 allow interest expenses in finance leases (as well as other related expenses like insurance and maintenance cost) to be deductible, and the same principle should apply under IFRS 16. This is in line with Section 24 of the Companies Income Tax Act {CITA}.
• Depreciation on the ROU asset, though recognized in the lessee's financials, may not be tax-deductible directly in line with Section 27 of CITA. Instead, the lessee could be allowed to claim capital allowances (tax depreciation) on the ROU asset, as with other fixed assets. The 
• Lease payments: Under IFRS 16, since the lease liability is recognized, lease payments are split between interest and repayment of the principal. Only the interest portion of the lease payments would be tax-deductible, while the principal repayment would be treated similarly to other loan repayments (i.e., the principal repayment is not tax-deductible in line with Section 27 of CITA).

2. Withholding Tax (WHT):

WHT in Nigeria applies to interest and rental payments, amongst others. Under IFRS 16:

• WHT would still be applicable on the interest portion of lease payments. The lessee is responsible for withholding tax at the applicable rate (10%) on interest paid to the lessor, similar to how finance leases were treated under IAS 17. WHT in this context is in line with Section 78 of the Companies Income Tax Act {CITA}.
• Since the ROU asset represents the lessee's right to use the asset, WHT on rentals may no longer be as relevant, especially if lease payments are structured in a way that distinguishes interest and principal. However, careful attention is needed to classify any service or additional payments that may attract WHT.

3. Value Added Tax (VAT):

Under IFRS 16, the treatment of VAT should be similar to the guidelines provided under IAS 17:

• VAT will likely still apply to the rental portion of lease payments (if applicable) or any service components related to the lease (maintenance cost, insurance, etc.). However, since under IFRS 16, the lessee recognizes the ROU asset and liability, VAT might only apply to the service component (maintenance cost, insurance), and not the interest portion. 
• 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.
• VAT paid on the acquisition of leased assets or services related to the lease would be treated as input VAT, which the lessee can recover, provided the lessee is VAT-registered and the asset is used for taxable supplies. This is in line with Section 17(1) of the Value Added Tax Act {VATA}.

4. Capital Gains Tax (CGT):

Under IFRS 16, if the lessee exercises the option to purchase the leased asset at the end of the lease term, Capital Gains Tax (CGT) could apply on the sale of the asset, but only if the asset is sold for a gain:

• The lessee would pay CGT at 10% if they dispose of the ROU asset after acquiring it, similar to how CGT applies to owned assets under 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.
• If the lessee sells their interest in the ROU asset (through a sublease or transfer), CGT could apply to any gain realized.

Read also: Tax Treatment for Lessors Under IFRS 16 in Nigeria

Summary:

In summary, under IFRS 16, the key tax treatments for lessees regarding ROU assets in Nigeria would likely include:

• Interest expense on lease liability is tax-deductible.
• Depreciation on ROU assets in financials is replaced by capital allowances for tax purposes.
• Withholding tax applies on the interest portion of lease payments.
• Input VAT may be recoverable.
• Capital Gains Tax may apply if the ROU asset or interest is disposed of.

These treatments are based on the FIRS approach under IAS 17, modified for the IFRS 16 model.