Sale and Leaseback, Deferred Tax on Leases and a Foreign-Currency Lease
Nirmal Ltd sold its headquarters building to a fund on 1 April 20X4 for ₹180 crore, its fair value, and leased it back for 12 years at ₹14 crore a year payable in arrears. The building's carrying amount was ₹120 crore and its remaining useful life is 40 years; the lease contains no transfer of ownership and no bargain purchase option, and Nirmal's incremental borrowing rate is 9%. Nirmal also leases a warehouse in Dubai for five years at USD 100,000 a year, payable annually in arrears, with the first payment on 31 March 20X5; the lease liability at inception was USD 421,236 at a 6% rate. Exchange rates: 1 April 20X4 ₹80; 31 March 20X5 ₹84; average ₹82. Nirmal recognised the sale and leaseback in its draft accounts by debiting cash ₹180 crore, crediting the building ₹120 crore and taking the entire ₹60 crore to profit. Its tax rate is 25.17%, and lease rentals are deductible for tax when paid.
1. Did the transfer qualify as a sale under Ind AS 115? What should Nirmal have recognised on 1 April 20X4?
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Sale or financing? The buyer obtains control of the building: Nirmal has transferred legal title, has no obligation to repurchase, and retains only a 12-year right of use out of a 40-year remaining life. The leaseback does not transfer substantially all the risks and rewards back to Nirmal. The transfer is therefore a sale under Ind AS 115, and the leaseback is a separate lease under Ind AS 116. (Had the leaseback covered substantially all of the asset's remaining life, or had the buyer been able to put the asset back, the transfer would have been a financing and the ₹180 crore a financial liability.)
Measurement. The lease liability is measured at the present value of 12 payments of ₹14 crore at 9%: annuity factor 7.1608, so the liability is ₹100.25 crore. The right-of-use asset retained is measured at the proportion of the previous carrying amount relating to the retained right:
- Retained ROU = 120 × 100.25/180 = ₹66.83 crore
- Gain on rights transferred = 60 × (1 − 100.25/180) = ₹26.58 crore
Entry at 1 April 20X4
| Dr | Cr | ₹ crore |
|---|---|---|
| Cash | 180.00 | |
| Right-of-use asset | 66.83 | |
| Building (PPE) | 120.00 | |
| Lease liability | 100.25 | |
| Gain on sale and leaseback (P&L) | 26.58 |
The draft accounts overstate profit by ₹33.42 crore and omit the lease liability and the retained right-of-use asset entirely.
2. How should deferred tax on the lease and the sale and leaseback be recognised at 31 March 20X5?
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The initial recognition exemption does not apply. Following the amendment to Ind AS 12 (deferred tax related to assets and liabilities arising from a single transaction), the exemption is not available to leases or decommissioning obligations. A temporary difference arises on initial recognition of the right-of-use asset and the lease liability, and both sides must be recognised.
At inception of the leaseback
- Lease liability ₹100.25 crore: tax base nil, because rentals are deductible only when paid. Deductible temporary difference → DTA = 100.25 × 25.17% = ₹25.23 crore.
- Right-of-use asset ₹66.83 crore: no tax deductions attach to it (the building's tax depreciation now belongs to the buyer; Nirmal deducts rent). Tax base nil → taxable temporary difference → DTL = 66.83 × 25.17% = ₹16.82 crore.
- Net DTA = ₹8.41 crore.
Sanity check. The tax on the full ₹60 crore gain was paid in 20X4-25, but only ₹26.58 crore of gain is recognised in the accounts. The unrecognised ₹33.42 crore of gain is effectively a prepaid tax of 33.42 × 25.17% = ₹8.41 crore, exactly equal to the net DTA above. The deferred tax reconciles the accounting deferral of the gain with the immediate taxation of it.
Subsequently. As rent is paid, the liability falls and the DTA reverses; as the ROU is depreciated, the DTL reverses. Both are recognised in profit or loss, except to the extent they relate to items recognised in OCI. Deferred tax is not recognised on the sale gain itself, which is already taxed.
3. How should the Dubai warehouse lease be translated at 31 March 20X5?
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The lease is a monetary liability and is retranslated at the closing rate; the right-of-use asset is a non-monetary item measured at historical cost and stays at the exchange rate on the transaction date (Ind AS 21).
Right-of-use asset (historical rate ₹80)
- USD 421,236 × ₹80 = ₹3,36,98,880 ≈ ₹3.37 crore
- Depreciation for the year: USD 84,247 × ₹80 = ₹0.674 crore (5-year straight line; not retranslated).
Lease liability
- Opening: USD 421,236 × ₹80 = ₹3.37 crore
- Interest at 6%: USD 25,274, translated at the average rate ₹82 = ₹20.72 lakh
- Payment: USD 100,000 × ₹84 (paid on 31 March) = ₹84 lakh
- Closing balance: USD 346,510 × ₹84 = ₹2,91,06,840 ≈ ₹2.91 crore
- Carrying amount before retranslation at the historical rate: USD 346,510 × ₹80 = ₹2.77 crore
- Exchange loss = ₹13.86 lakh, recognised in profit or loss (Ind AS 21 para 23(b)).
Key points an examiner will look for
- Only the liability is retranslated; the ROU asset is not, so no exchange difference is capitalised.
- The average rate is acceptable for the interest expense (Ind AS 21 para 22) but the payment is translated at the transaction-date rate.
- The short-term and low-value exemptions are not available (five years, material).
- The USD lease must not be netted with any foreign-currency monetary asset; the exchange difference is presented separately or disclosed as required by Ind AS 1.