Recording the consequences of termination of lease agreements in tax accounting

Posted: Valeriy Posted: 28 April 2017 12:52 Category: MinTax Group News Views: 796

By Gaukhar Narbekova, MinTax Group Partner, Certified Auditor. When doing business, it happens sometimes that due to insolvency of one of  the parties of the leasing agreement, the leased item is returned. In this case, questions frequently arise as to how the consequences of such changes should be correctly reflected in the taxpayer’s tax records. In this article, we will speak about such consequences of termination of leasing agreement and the procedure for their recording by one of the parties of a leasing agreement. 

The purpose of this article is to find justified answers to the following questions: in which tax period does the additional assessment apply for value-added tax (VAT) and corporate income tax (CIT) on the previously exempted lease interest turnover; when an invoice should be issued for the returned leased item, lease interests; how all these occurrences should be reflected in the tax accounting of the parties under the leasing agreement?
For example, due to sudden financial difficulties (emergency occurrence), the Company, which is the lessee under the leasing agreement, has entered into the conditions stipulated in the leasing agreement, implementation of which became impossible. In this case, in accordance with the terms of the leasing agreement, the party to the contract, in the event of failure to fulfil its financial obligations, must return the leased item. The unfavourable event occurred before expiry of the three-year period from concluding the leasing agreement and transfer of the leased item.
According to Article 23 of the Law of the Republic of Kazakhstan No. 78-II dated July 5, 2000 "On Financial Leasing", the lessee must return the leased asset unless the leasing agreement provides for the right or obligation of the lessee to acquire the leased item, or he used the stipulated right to purchase the leased asset, or the leasing agreement was terminated ahead of schedule in court procedure, as well as in other cases stipulated by the leasing agreement and legislative acts of the RoK. In such case, the leased item must be returned in the same condition in which it was received by the lessee, taking into account normal wear and tear, or in a condition stipulated by the leasing agreement.
Pursuant to sub-paragraph 1) of paragraph 4 of Article 78 of RoK Code #99-IV dated 10 December 2008 "On Taxes and Other Obligatory Payments to the Budget" (Tax Code) the following is not regarded as financial lease:
o leasing transactions in the case of termination of underlying leasing agreements prior to the expiry of three years from the date of conclusion of such agreements, except for the following cases:
o recognition of the lessee as bankrupt in accordance with the RoK legislation on rehabilitation and bankruptcy and its exclusion from the National register of business identification numbers;
o recognition of a natural person – lessee on the basis of a court decision which entered into force as missing or declaring him deceased, or legally incapable, or restrictedly competent, establishing his invalidity of I, II group, and also in the case of death of the natural person – lessee;
o entering into legal force of a resolution of a law enforcement officer on the return of the court orders to the lesser in connection with the absence with the lessee of assets, including money, securities or income on which recourse may be taken, and where the measures taken by the law enforcement officer specified by the legislation of the Republic of Kazakhstan on enforcement proceedings and the status of law enforcement officers on disclosure of his assets, including money, securities or income turned out to be fruitless;
o entering into legal force of a court decision on the denying the lesser taking recourse on the assets of the lessee, including on money, securities or income;
o granting the leased items into secondary lease.

In accordance with paragraph 17 of Article 238 of the Tax Code, in case of failure to comply with requirements established by Article 78 of the Tax Code, the size of exempted turnover, when assets are transferred to financial leasing, is recognized as taxable from the date of committing a turnover specified in paragraph 6 of Article 237 of the Tax Code.
In the meantime, according to paragraph 6 of Article 237 of Tax Code, where the lessor transfers into a financial lease assets which are received by the lessee as main assets, investments into real estate, biological assets, except for transfers under returnable lease agreements, the following shall be recognised as a date of commission of sales turnovers:
1) the maturity date established by the financial lease agreement for receipt by the lessor of a periodical lease payment, except for the cases specified in subparagraphs 2) and 3) of this paragraph;
2) in the event that according to the financial lease agreement the maturity date for receipt by the lessor of the lease payment is established before the date of the transfer of assets to the lessee, the date of transfer of assets into financial lease shall be recognised as a date of commission of the turnover.
According to paragraph 1 of Article 78 of Tax code, transfer of assets under financial leases concluded in accordance with the RoK legislation, for a period in excess of three years, shall be recognised as financial leasing, provided it meets one of the following requirements:
1) transfer of assets into possession of a lessee and (or) providing the lessee with the right to purchase assets at a fixed price as defined in the lease agreement;
2) period of a finance lease exceeds seventy-five percent of the useful life of the assets to be transferred in accordance with the finance lease;
3) current (discounted) value of the lease payments for the entire period of the finance lease exceeds ninety per cent of the value of the assets to be transferred under the finance lease.
Moreover, in accordance with sub-paragraph 1) of paragraph 2 of Article 133 of Tax Code, a taxpayer has the right to reduce taxable income by the amount of interests on financial lease of fixed assets, investments in real estate, biological assets.
According to sub-paragraph 39) of paragraph 1 of Article 12 of the Tax Code, any payments relating to transfer of property under a financial leasing agreement, including payments to a related party in connection with such agreement are recognized as interests under financial lease, with the exception of:
- value at which such assets were received (transferred),
- payments in connection with the change in the amount of lease payments when applying a coefficient (index) in accordance with the terms of a financial leasing agreement,
- payments to a person who is not a lessor, a related party for the lessee.
In this connection, if the conditions of Article 78 of Tax Code are not met, the transfer of property under a leasing agreement is not recognized as financial lease for tax purposes, accordingly, payments under such leasing agreement are not deemed to be interests under financial lease and are subject to taxes in accordance with the generally established procedure.
Thus, taking into account the above, it can be concluded that, upon termination of the leasing agreement where the conditions of Article 78 of Tax Code are not met, lease payments are subject to taxation under the generally established procedure from the date of concluding such a leasing agreement. At that, a taxpayer who is a lessor is required to submit additional CIT Declarations for tax periods in which the lease payments received by him were recognized as interests under financial lease by the amount of which his taxable income was reduced.
Accordingly, the taxpayer being a lessee is required to submit additional CIT Declarations for relevant tax periods in which depreciation deductions and deductions of interests associated with the use in activities aimed at earning income were recognized.
In this case, in accordance with paragraph 2 of Article 70 of Tax Code, the following should be specified in relevant lines of additional tax reporting:
1) difference between amounts shown in the previously submitted tax reports and actual tax liability for the tax period — where amounts in previously presented tax reports are changed;
2) new values — in case of changes in other data of the previously submitted tax reports.
Due to failure to comply with requirements of Article 78 of Tax Code, previously committed turnovers do not meet the definition of financial lease and are subject to additional VAT assessment from the date of committing a sales turnover specified in paragraph 6 of Article 237 of Tax Code (from the date of transfer of assets to a financial lease).
Often in practice, both taxpayers and tax authorities, when conducting tax audits, instead of calculating tax liabilities retrospectively (dating back to each of the relevant tax periods preceding the date of termination of obligations under the leasing agreement in connection with its early termination) calculate tax liabilities only in the period when the leased asset was returned as an adjustment to previously recognized deductions and revenues, which contradicts to the above-mentioned special rule of Article 78 of Tax Code specially provided for cases of non-compliance with all conditions and the definition of financial lease for tax purposes.
Author very much hopes that this article will be useful to taxpayers in resolving disputes with supervisory bodies arising on occurrence of the foregoing cases.
This material is subject to copyright. Reprinting and other use is prohibited by the copyright holder. This material expresses the author's opinion and is a recommendation. This material is based on regulatory acts in force at the time of publication.

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