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Concept of Leasing in Tax Accounting

The definition of leasing and its types in tax accounting is different from that provided in civil law. Besides, there are differences in terms used in civil and financial (in particular, tax) legislation .

The Law of Ukraine “On Corporate Profit Tax” (hereinafter “Law on Profit Tax”) defines “leasing” as a business transaction of an individual or a legal entity (lessee) that envisions the provision of fixed assets or land in use to other individuals or legal entities (lessors) in exchange for leasing payments and for a defined term. There are the following types of leasing transactions:

financial leasing;
operating leasing;
reverse leasing;
lease of land;
lease of residential premises.

In accordance with tax law, financial leasing is business transaction of an individual or legal entity that, in accordance with financial leasing contract, transfers to a lessee the property purchased or manufactured by a lessor, as well as all risks and premiums related to the right to use and possess leasing asset.

Leasing is considered to be financial lease if leasing contract includes one of the following requirements:

The leasing asset is provided for the term over which no less than 75 per cent of its initial value is depreciated in accordance with the depreciation rate stipulated by the Law on Profit Tax, and the lessee is obliged to buy leasing asset during the term of leasing contract or at the moment of its expiry at the price stipulated by this contract.
The amount of leasing payments from the beginning of the term of leasing equals or exceeds the initial value of leasing asset.
If leasing asset was part of lessor’s fixed assets and 50% of its initial value has been depreciated, total amount of leasing payments must be equal or exceed 90% of regular price for such asset, effective as of the beginning of the term of leasing contract plus interest calculated based on the NBU discount rate determined as of the beginning of the term of leasing contract for the entire term of the contract.
Property transferred in financial leasing has been manufactured upon the order of a lessee and after the expiration of leasing contract may not be used by persons other than a lessee due to its technological and qualitative characteristics.

Operating leasing is defined by tax legislation as business transaction of an individual or legal entity whereby in accordance with operating leasing agreement a lessee receives the property (purchased or manufactured by a lessor) on the terms other than those stipulated by financial leasing.

It is worth noting that irrespective of whether or not leasing transaction is regarded as financial leasing, during the conclusion of agreement the parties may stipulate such transaction as operating leasing (without the possibility to change the status of such transaction until the validity period of respective agreement expires).

Reverse leasing is business transaction of an individual or a legal entity that envisions the sale of fixed assets to a financial organization whereby such individual or legal entity simultaneously obtains those assets in operating or financial leasing.

Object of Taxation

Taxable profit (or the object of taxation) shall be calculated pursuant to the following scheme:

The Law on Profit Tax includes an exhaustive list of types of income, which are included in the taxpayer’s gross income as well as expenses that may be included in its gross expenses [i.e. deducted for tax purposes].

In particular, insurance expenses are deductible only up to five per cent of gross expenses in the reporting tax period (progressive total from the beginning of the year) . If leasing asset is vehicles (transport means), such a limitation entails a significantly higher price of the leasing service. To minimize their risks when providing vehicles on lease, leasing companies undertake to conclude insurance contracts on an annual basis including the cost of insurance and the leasing contract.

The Date of Increasing the Gross Income and Gross Expenses

The date of increasing the gross income or gross expenses shall be the date occurring in the tax period during which any of the earlier operations occurred:

To calculate gross income:

the date of crediting vendor’s (customer’s) funds to the bank account of the taxpayer as payment for goods (works, services), and should such be absent – the date of collecting cash by a banking institution servicing the taxpayer;
the date of shipping goods and in the event of works (services) - the date of providing actual results of works (services) by the taxpayer.

To calculate gross expenses:

the date of debiting taxpayer’s bank accounts to pay for goods (works, services), and should such be purchased for cash – the date of issuing cash at the taxpayer’s cash desk;
the date of receipt of goods by the taxpayer and in case of works (services) – the date of receipt of actual results of works (services) by the taxpayer.

If the taxpayer carries out transactions with:

- non-residents or
- residents who:
   o pay the profit tax at a rate lower than 25 per cent (except for insurance activity), or
   o pay this tax as part of the unified or fixed tax, or
   o are exempted from paying this tax, or
   o are not subjects of profit tax,

the date of increasing gross expenses shall be the date of receipt of goods by the taxpayer (and in case of import – also the receipt of works (services) related or auxiliary to such import); and in the event of works (services) - the date of their actual receipt from such persons whether or not payment has been made (including partial or advance payment).

Calculation of Tax Base in Case of Financial Leasing

For tax purposes, the transfer of property for financial leasing is considered the same as sale transaction as of the moment of such transfer.

Lessor’s Tax Base

When transferring the leasing asset to a lessee, a lessor increases its gross income in the tax period during which such transfer occurred. Accruing leasing payments, a lessor increases its gross income by the amount of interest and commissions accrued to the value of leasing asset based on the results of the tax period in which such accrual occurs.

If a lessee does not purchase leasing asset and returns it to a lessor:

- for tax purposes such return is equivalent to a reverse sale of leasing asset by a lessee to a lessor at a regular price prevailing as of the moment of such sale (but not lower than its initial value less accumulated depreciation in accordance with the Law on Profit Tax).
If contract value of leasing asset (which is put into operation for the first time) is lower than the costs of its acquisition or installation, tax authorities are entitled to conduct an extraordinary inspection to determine the regular price.

Lessee’s Tax Base

In case of receipt of leasing asset, a lessee shall increase the book value of the relevant group of fixed assets. Accruing lease payments, it increases its gross expenses by the amount of interest and commissions accrued to the value of leasing asset based on the results of the tax period in which such accrual occurs.

Calculation of Tax Base in Case of Operating Leasing

Lessor’s Tax Base

By providing property for operating leasing, a lessor does not change its tax liability.

Gross income of a lessor is increased when a lessor accrues leasing payments. Gross income is increased by the amount of accrued leasing payments based on results of the tax period in which such accrual occurs.

Lessee’s Tax Base

The receipt of property for operating leasing does not change tax liabilities of a lessee.
Gross expenses of a lessee are increased upon the accrual of relevant leasing payments. The increase shall equal the amount of such payments based on the results of the tax period in which such accrual occurred. It is worth noting, that if the object of operating leasing is a car, only 50 per cent of leasing payment is deductible.

Gross Income and Expenses for Settlements in Foreign Currency

If during the tax period the taxpayer had the following types of transactions in foreign currency:

received (accrued) income included in its gross income, or
incurred (accrued) expenses included in its deductible expenses, then:

such income and / or expenses shall be translated into UAH at the official exchange rate of the NBU effective as of the date of receiving (accruing) such income and incurring (accruing) such expenses.

Creation of Insurance Reserves

In accordance with the Law on Profit Tax, leasing companies which are financial institutions, are mandated to create the insurance reserve to cover possible losses on the principal (without interest and commission fees) .

The amount of insurance reserve must be sufficient to fully cover the risks of non-repayment of principal debt. A leasing company creates such insurance reserve independently in accordance with the methodology to be developed by the State Committee for Regulation of Financial Services Market .

Part of the insurance reserve may be formed through the increase of gross expenses of a leasing company. The size of this portion of the insurance reserve (1) may not exceed the amount stipulated by law for such financial institution and (2) shall not exceed 15% of the amount of debt claims. The amount of debt claims means aggregate obligations of leasing company’s debtors as of the last working day in the reporting tax period.

Profit Tax Rate

For residents of Ukraine (lessors and lessees) the profit tax rate is 25% of the taxable amount.

For non-residents of Ukraine or their authorized representatives the profit tax rate is 15% of the amount of payments made it their favor by the resident or permanent representative office of a non-resident from income originating in Ukraine. Tax is paid from such income. Tax is paid to the budget on paying income to the non-resident, unless otherwise stipulated by the provisions of international treaties.

Taxation of Non-Residents

For profit tax purposes, income received by non-residents and originating in Ukraine as a result of leasing transactions shall be leasing payment, which that is paid (accrued) by residents or permanent representative offices in favor of a non-resident lessor. Tax is paid from this same income in the amount of 15%, unless otherwise stipulated by the provisions of bilateral international treaties.