Enabling a consistent approach to tax affecting your leases and decommission responsibilities

For the year ended 30 June 2024 (and 31 December 2023), entities are required to recognise a related deferred tax asset (DTA) and a deferred tax liability (DTL) for leases and decommissioning liabilities.

In June 2021, the Australian Accounting Standard Board (AASB) published AASB 2021-5 Amendments to Australian Accounting Standards – Deferred Tax related to Assets and Liabilities arising from a Single Transaction to clarify that the initial recognition exemption does not apply to transactions that gives rise to an asset and a liability simultaneously.

Common examples of transactions that give rise to an asset and a liability simultaneously are when:

• a lessee enters into a lease, and recognises a right of use (ROU) asset and a lease liability
• an entity has decommissioning obligations, and recognises a provision for the expected costs of the decommission obligation, and a corresponding amount is capitalised into the cost base of the related asset.

Before the amendments were published, there was diversity and inconsistency in practice. Some entities applied the initial recognition exemption in AASB 112 Income Taxes and did not recognise the associated DTA or DTL, whereas others recognised the related DTA and DTL.

The amendment clarified that entities do not apply the initial recognition exemption in AASB 112. Therefore, an entity must recognise both a DTA and DTL for transactions that give rise
to the recognition of an asset and a liability.

The clarification applies from annual reporting periods beginning on or after 1 January 2023 (ie for 31 December 2023 and 30 June 2024 year ends) and at the beginning of the earliest comparative period presented.

The cumulative effect is recognised as an adjustment to the opening balance of retained earnings, or another other component of equity at that date.

Example

Entity A enters into a five year lease. Annual lease payments are $1,000 per year in arrears. Entity A’s incremental borrowing rate is 10%. Initial direct costs relating to the lease is $10.

Both the lease payments and initial direct costs are tax deductible when Entity A makes those payments. Entity A’s tax rate is 30%. On entering into the lease the lease liability is therefore $3,790 and the ROU asset is $3,800 (lease liability of $3,790 plus initial direct costs of $10).

In summary, there has been diversity in recognising deferred taxes on leases and decommissioning obligations over the years, which has caused inconsistency in reporting. The amendments will narrow the exemption in AASB 112 and provide improved comparability and more relevant information to users of financial statements.

Please reach out to the PKF technical team for further details if required.