Changes to lease accounting rules in FRS102, which align UK GAAP with international accounting standards following the introduction of IFRS 16, come into effect for accounting periods beginning on or after 1 January 2026. Businesses which account under FRS 102 and have December year ends will therefore be adopting the new accounting standard from last month. Under the new rules, a lessee does not distinguish between a finance lease and an operating lease, and most leases will need to be recognised on-balance sheet – with the exception of leases of assets of low value (such as computers or mobile telephones) and short-term leases (term of less than 12 months). Further information on the changes to FRS 102 is available in this EY accounting alert.
Whilst many businesses will be familiar with the concept of capitalising leases in respect of plant and machinery, motor vehicles and/or fixtures and fittings, particular complexity arises with regard to the capitalisation of property leases. What the rules mean in practice is that a property lessee recognises a right-of-use (RoU) asset on its balance sheet to reflect the fact that the right to occupy and use a building under a lease for a defined period is itself an asset. This is matched by a corresponding finance lease liability.
With the change in accounting treatment, any charges to the income statement will now reflect depreciation, impairment and notional ‘finance costs’ in respect of leases. However, it does not automatically follow that all such charges are tax-deductible, and care needs to be taken in identifying and calculating any necessary adjustments to taxable profits. In particular, it is important to ensure no relief is being taken for capital items within the RoU asset (such as direct costs associated with leases or elements of the dilapidations provision).
We are aware of companies that apply IFRS 16 and FRS 101 having received ‘nudge’ letters from HMRC checking whether their tax treatment of depreciation (and any impairment) is correct, specifically requesting details of how capital items have been identified and disallowed. Therefore, we expect this to be a focus area for HMRC going forward, and taxpayers who account under FRS 102 should ensure they get their position right from the outset to mitigate the risk of challenge in the future. This will be particularly relevant for those businesses with a large occupational footprint, include those in the retail, hospitality, financial services, industrials and healthcare sectors.
EY’s Capital Assets Tax Services (CATS) team have extensive experience of helping businesses to navigate this complex area, including analysing leasehold property expenditure to determine the appropriate capital/revenue split, and designing and agreeing bespoke methodologies with HMRC. If you would like more information on the tax implications, both in terms of property leases and other asset leases more broadly, or would like to discuss how the CATS team could help you work through these issues, please get in touch with your local EY contact or one of the contacts listed below.
