Value Added Tax (VAT)
№ 9 (September 2006)
To Lease or Not to Lease, What Saith the Taxman
Taxation rules pertaining to leasing transactions always raise many questions – we will try to answer them in this article.
By Tatyana Khodorkovskaya
When bringing equipment under a lease contract from abroad, the lessee pays the VAT twice:
– at the customs, as a buyer of equipment;
– making lease payments to the lessor (non-resident), becoming a tax agent.
The computation procedure for the VAT when goods are moved across the customs border of the Russian Federation is covered by the Tax Code of the Russian Federation (TCRF) (Art. 151, chapt. 21), the tax is paid in full when the goods are released for free circulation (subpar. 1, par. 1, Art. 151, TCRF).
So, the lessee organization pays the VAT as part of the customs charges when it clears the goods through the customs under this regime.
Later, the lessee, registering with the tax authorities, has the right to deduct the VAT amount (Art. 172, TCRF).
If the equipment is entered into the lessee’s books, it is included into the organization’s fixed assets, account 01.
If the equipment is carried on the lessor’s books, the lessee includes it into off balance sheet account 001 – “Rented Fixed Assets”. According to Art. 665 of the Civil Code of the Russian Federation, lease contract is a contract of financial lease, whereby the lessor obligates to acquire the property for the lessee and to give it to the lessee for a compensation, for temporary use and possession for business purposes. When the equipment is leased on the territory of the Russian Federation, the service is deemed to be performed in the Russian Federation and the lessor becomes a payer of the VAT from the lease payments. If the organization-nonresident (lessor) is registered with the Federal Tax Service Inspection as an independent taxpayer, the organization is to pay the VAT independently. In other case the lessee, making lease payments to the lessor, becomes a tax agent and must be withholding the VAT (Art. 161, TCRF) from the lease payments. The tax amount withheld must be paid to the budget concurrently with payments to the foreign company. The VAT amount may be later deducted when the organization (lessee) pays taxes associated with its principal activities, during those tax periods when the lease payments are effected.
According to subpar. 10, par. 1, Art. 264 of the TCRF, rentals (leasing payments) for rented (received under a lease contract) property are subsumed under the other outlays. Leasing payments are understood as being the total amount of payments under the lease contract for the entire duration of the contract, including a reimbursement of the lessor’s expenditures connected with the acquisition of the leased asset and its delivery to the lessee, and also the lessor’s remuneration (par. 1, Art. 28, Federal Law #164-FL on leasing). The lease payments may also include the redemption price of the leased asset, if the lease contract provides for the transfer of the title to the leased asset.
For the purposes of profit taxation, outlays of the lessee such as the redemption price of the leased asset are considered as outlays on acquisition of a depreciated property, and in accordance with par. 5, Art. 270 of the TCRF these outlays are not factored in when defining the tax base for the profit tax. The inclusion of the depreciated property cost into the organization’s outlays for the purposes of taxation is effected through the mechanism of depreciation (Arts. 256-259, TCRF). So, lease payments are included into outlays inasmuch as these payments pertain to acquisition of the leased asset. The redemption price of the leased asset is not included into lease payments for the purposes of profit taxation (subpar. 10, par. 1, Art. 264, TCRF).
After all, prior to the transfer of title to the leased asset the redemption price is not considered either as the lessor’s profit or the lessee’s outlay.
According to Article 357 of the TCRF, payers of the transport tax are persons in whose name are registered means of transportation that are recognized as objects of taxation in accordance with Art. 358 of the TCRF. The payment of the tax is effected by the taxpayers at the vehicle’s location, in the manner and during the time period prescribed by the constituent entities of the Russian Federation.
According to par. 2, Art. 17 of the Federal Law #164-FL, the leased asset is leased together with all its components and with all documents, unless otherwise specified in the lease agreement.
Procedures for registering the property (leased asset) and the rights to it are covered by Article 20 of Federal Law #164-FL. Thus, in cases provided for in the law of the Russian Federation, the rights to the property leased, as well as the lease contract whose subject is the property in question, must be registered with the authorities.
Considering all the above, if the asset leased is a motor vehicle, the law of the Russian Federation states that it must be registered at the State Traffic Safety Inspectorate.
As a result, the lessee becomes a payer of the transport tax.
This tax is paid by the lessor, who is the owner of the leased asset. This tax is a part of the lease payments, and the lessee includes it in its entirety into the other outlays at the period when the lease payments are made.
The key advantage of leasing an equipment is the right of the parties to the lease contract to use the mechanism of accelerated depreciation with a co-efficient not bigger than 3 both with the linear method and non-linear depreciation computation methods for taxation purposes. Moreover, if the leased asset is used for work under the conditions of an aggressive environment, which accelerate the asset’s wear and tear, the co-efficient 3 may be multiplied by an additional coefficient, though no bigger than 2 (par. 7, Art. 259, TCRF). The accelerated depreciation of a leased asset has but one limitation: it does not apply to the fixed assets of the first, second and third depreciation groups, if their depreciation is computed using the non-linear method. A leased asset may be carried either on the lessor’s books or the lessee’s books (par. 1, chapt. 31, Federal Law of October 29, 1998 #164-FL). Depreciation deductions are made by that party to the lease contract on whose books the leased property is carried.
The accelerated depreciation arrangement allows the lessee to diminish considerably the profit tax payments during first years after the acquisition of fixed assets regardless of whose books the property is carried on – the lessee’s or the lessor’s. After the transfer of the title, the leased asset is accounted by the lessee at its redemption value, which in most cases is a residual value and, therefore, the lessee is to own later a completely depreciated equipment and to pay less in property taxes.