Financial Reporting Standard 102 (FRS 102) is the primary accounting standard in the UK and Republic of Ireland for entities that do not use IFRS, FRS 101 or FRS 105. FRS 102 is generally used by private companies and provides a single set of accounting requirements for general-purposes financial statements, aiming to offer a true and fair value of an entity’s financial position.
To discuss how the upcoming FRS 102 changes in leases could impact your business and tax position, get in touch with our experts, today.
What has changed in accounting
The Financial Reporting Council previously issued amendments to FRS 102 that are effective for accounting periods starting on or after 1 January 2026. This revision will mean no longer distinguishing between operating leases and finance leases, rather a move towards the same treatment as finance leases for all but a few exempt leases.
Prior to the implementation of this amendment, finance leases had depreciation charged on the asset and interest released on the lease liability to the P&L both of which would be deductible for tax purposes in the calculation of taxable trading profits. Lease premiums and SDLT will continue to be non-deductible.
Operating leases had fully deductible rental payments charged to the P&L (subject to deduction restrictions for certain leased cars).
The FRS 102 changes mean that for all leases, lessees will be required to recognise a lease liability on their balance sheet that reflects the promise to make future rental payments under the lease contract. They will also recognise a corresponding right-of-use (ROU) asset on the balance sheet, reflecting exclusive use of the underlying asset.
Therefore, operating lease rental expenses as recognised under old FRS 102 are replaced by depreciation on the ROU asset and a finance charge on the lease liability.
Optional recognition exemptions for lessees are permitted for short-term leases and leases of low-value assets to remain off-balance sheet. These can continue to be accounted for similarly to the old operating leases.
A short-term lease is one which, at the inception of the lease, has 12 months or less to run. A lease that contains a purchase option is not a short-term lease.
What are the tax impacts
With tax treatment following the accounting treatment, recognising leases as finance leases means depreciation and interest charges will continue to be deductible as they are released to the P&L and there will no longer be rental payments associated with the majority of operating leases.
Following the amendments, the broad impact on the tax treatment of leasing transactions will be apparent where the entity’s accounting profits are used as the basis for determining taxable profits.
When similar changes were made to International Accounting Standard 16, there were spreading provisions for transitional adjustments. For FRS 102, there is no restatement of comparatives, so it is thought that the spreading provisions will only be relevant if a company makes an accounting election to adopt the IFRS numbers used by its IFRS parent as the starting right of use asset and lease liability amounts.
By recognising ROU assets, the gross assets on the business balance sheet will increase, which may impact eligibility for certain reliefs and tax efficient investments. For example, some tax reliefs are only available to companies of a certain size, such as the Enterprise Investment Scheme (EIS), Seed EIS, Enterprise Management Incentives (EMI) and the Enhanced R&D Intensive Scheme for R&D tax credits.
Where taxation of the leases does not follow the accounting treatment there will be deferred tax consequences on the newly originated temporary differences in the financial statements. These will also arise where differences occur in how lessees account for cash rentals vs the depreciation and interest P&L charges.
In addition, an increased interest expense could impact the Corporate Interest Restriction (CIR). Interest on what were previously classified as operating leases was excluded for CIR purposes, however interest for finance leases will not be. As such, this could increase tax costs by restricting the amount of finance costs deductible for tax purposes.
The treatment of assets on the balance sheet will need to be carefully tracked for tax purposes, identifying the ROU assets and also whether these are under operating, finance leases or hire purchase, so the capital allowances treatment can be correctly applied.
How PEM can help
Please get in contact with us to understand fully how these changes might impact your business and how PEM can help guide your business through the transition to the new standard.
This article was correct at the time of publishing.
