Is a novated lease a ‘lease’ for the employer under IFRS 16?

All leases currently classified as ‘operating leases’ by lessees in accordance with IAS 17 Leases will, under IFRS 16 Leases, need to be assessed to determine whether a right-of-use asset and lease liability need to be capitalised on balance sheet for periods starting from 1 January 2019.

The maths used to calculate right-of-use assets and lease liabilities is not easy! It is therefore imperative that entities assess all ‘lease’, rental and service contracts as a matter of urgency to determine whether there is a right-of-use asset and lease liability to be capitalised.

One example of such an agreement to be considered is a ‘novated lease’.

What is a ‘novated lease’?

An employee may enter into a lease arrangement with a finance company (usually for a motor vehicle) and then enter into a three-way agreement with their employer and the finance company whereby:

  • The employer takes on the obligations of the lessee
  • The terms of the agreement provide that if the employee ceases employment, the novated (three way) arrangement ceases, and obligations under the original lease will revert to the employee, and
  • The employee also has the risk for the residual value (balloon payment).

How should the employer entity account for a novated lease arrangement under IFRS 16?

The employer entity would not have a lease as defined in IFRS 16 because the contract does not convey the right for the employer to control the use of an identified asset. The vehicle is effectively the employee’s vehicle to use as he/she wishes, with the lease payments being a salary sacrifice to optimise the employee’s tax position.

IFRS 16, paragraph B9, states that to assess whether a contract conveys the right to control the use of an identified asset, an entity shall assess whether it has both:

  1. The right to obtain substantially all the economic benefits from use of the asset, and
  2. The right to direct the use of the identified asset.

It is the employee, not the employer, who has the rights in 1. and 2. above, with the substance of the arrangement being that the employer entity is simply facilitating a tax effective way for the employee to obtain the vehicle.

If you require assistance

If you require assistance with any other IFRS 16 implementation issues, please contact your engagement partner or BDO IFRS Advisory Services.