Inform

New legislation to affect consumer and SME finance across the EU

Authored by Ludwig Fischer and Thomas Scharrenberg

Writing consumer finance business in the past has always required special procedures and documentation in order to comply with local legal provisions for consumer protection. From this year these requirements will be further tightened in most European countries.

In 2010 all EU members are required to adopt the EU Directive 2008/48/EC on credit agreements for consumers. The intention is to increase consumer protection by requiring the financial services industry to provide a comprehensive set of standard information to the customer according to SECCI (Standard European Consumer Credit Information ) prior to signing the contract. Not only that but in the case of a credit decline based on credit reference agency information, the industry will be required to provide details on the reasons for the decline to the consumer.

Although the legislative procedures are not finalised yet in many countries, the financial services industry will certainly face an additional administrative burden when doing business with consumers. In Germany for example the BDL (German Leasing Association) legal sub-council has put together a 7 page document with detailed procedural descriptions and template recommendations to assist lenders in complying with the expected new rules.

The industry is required to change quickly as the new rules will have to be in place soon, for example June 2010 is the expected go live date in Austria and Germany. As a consequence several German leasing companies which have previously served the consumer market on an opportunistic basis have now decided to exit the consumer finance market completely in order to avoid the additional bureaucracy and costs. Will the gap be filled by existing lenders or is there an opportunity for new entrants?

However the impact of this legislation is more significant than that. According to the EU Directive these extended consumer rights will also have to be applied to founders of new businesses with the result that the financial services industry in Germany is about to pull back from this market as well. At a time when lenders are being urged by governments - and the EU - to lend to the SME sector, here is legislation being imposed which will have precisely the opposite effect! For those lenders that remain in the market, less competition should provide the opportunity to increase margins provided that this is not offset by the cost of legislative compliance.

For more information on legislative changes in Germany contact Ludwig Fischer on +49 7073 913 265; e-mail ludwig.fischer@invigors.com, or Thomas Scharrenberg on +49 212 64285520; e-mail thomas.scharrenberg@invigors.com.

Regulation – a new challenge for the leasing industry in Germany

Authored by Thomas Scharrenberg

Unlike many other European countries the German finance leasing market has previously not been regulated and it was quite easy to start and run a leasing business until 2008. But things have changed and it was the industry itself which unintentionally caused this change.

The German leasing industry had complained about a competitive disadvantage compared to banks regarding trade tax treatment. In 2008 its lobbying finally succeeded and the leasing business obtained the same favourable trade tax treatment as bank loans. But the new legislation had a political price, as of 2009 the industry was taken under the regulation of the Federal Financial Supervisory Authority (“BaFin”) and any organisation wishing to provide financial services now needed written authorisation. As a consequence finance leasing companies now have to comply with the German Banking Act (“Kreditwesengesetz”).

Although the level of regulation is much lower than applied to fully authorised banks it is a challenge for the leasing industry to cope with the new requirements such as ensuring appropriate risk management and control systems, adequate business contingency plan and well documented processes. In addition leasing companies have to fulfil specific reporting requirements such as submission of annual reports and accounts to BaFin as well as regular filings for large exposures or any changes to shareholders, directors, auditors or other relevant matters.

It is obvious that leasing companies which are bank subsidiaries should have only minor issues in coping with the new requirements as they already had most of the necessary structures and processes in place. But independent and especially smaller leasing companies are struggling to comply with the new standards, even though each existing company was only required to notify BaFin.

New market entrants however have to get a BaFin authorisation prior to starting their business. Applications must demonstrate a capable management and the new organisation’s ability to meet the standards. Although BaFin is the authority that grants the licence, the involvement of Deutsche Bundesbank is mandatory as BaFin requests this authority’s opinion prior to making a decision. As a consequence the application process requires a highly professional approach and a well defined project plan.

Invigors is currently providing clients with the advice and practical support to enable them to meet the BaFin regulatory requirements.  For further information on the German market contact Ludwig Fischer on +49 7073 913 265; e-mail ludwig.fischer@invigors.com, or Thomas Scharrenberg on +49 212 64285520; e-mail thomas.scharrenberg@invigors.com.

UK Pre-Budget Report

Authored by George Tonks

The Chancellor delivered his UK pre-Budget report on 9 December, confirming that the recession had been deeper than he had previously forecast, but predicting that the UK would return to growth from late 2009. Various positive comments followed about the state of the UK economy after 2010, although that will be after the next election, so we may well be under a different fiscal regime at that point. The growth in public sector borrowing was reported as higher than previously forecast, although not as bad as some had feared, with action proposed to reduce that and public sector spending from 2011/12. The overall picture given by the Chancellor should lead to more positive conditions for asset finance companies, although it is only his forecast.

A number of initiatives on “green” issues and the extension of the EFG may bring opportunities for asset finance companies.

On tax issues, the main headlines went to the new 50% levy on bankers’ bonuses in excess of £25,000, although we will have to wait and see whether this turns out to be simply a populist gimmick, or whether it has any substantial effect. Of more mainstream significance to asset finance companies is the further increase in NI rates and the confirmation of the return of the main VAT rate to 17.5% from 1 January 2010. Interestingly, at the same time, the Irish Government was announcing a 0.5% cut in its VAT rate, to 21%, although it had initially increased the VAT rate in response to the economic crisis. Also at the start of December, the UK Government had announced that HP transactions following the finance company’s normal commercial practice could fall outside the anti-forestalling provisions.

Further tax changes included an election to apply an alternative methodology for the effect of FA 2006 Sch10 (change of ownership of a lessor company), a move to ensure a staged sale of a lessor company falls within FA 2006 Sch10 and anti-avoidance provisions attacking structured arrangements which seek to take part of the income from an equipment lease out of UK tax, whilst still claiming full tax reliefs.

If you would like to find out more on any of these matters please contact George Tonks on +44 (0)845 003 1000 or e-mail: george.tonks@invigors.com

Lease Accounting - Standards reform back on track

Authored by George Tonks

The International Accounting Standards Board and the US Financial Accounting Standards Board have continued to discuss the reform of lease accounting since issuing their joint discussion paper in March. They are continuing on track to issue a formal exposure draft of the new accounting standard in Q2 of 2010, with the final standard following about one year later, so that it seems likely that changes will be effective from 2012. These changes are additional to the change in IAS 16 which results in some leasing companies reporting substantially increased turnover this year.

Having made the decision in 2008 that consideration of lessor accounting should be deferred, the Boards now seem determined to bring it back into this new accounting standard, with time spent at each of the last two monthly meetings on lessor issues. The Boards have also indicated that “in-substance purchases” should be outside the scope of the new accounting standard, although they have not clarified what that phrase means.

The IASB/ FASB proposals for revising lessee accounting are now well developed:

• Lessees will report an asset and a liability for any lease, with the initial asset and liability amounts equal to the present value of the minimum lease payments over the longest period for which the lessee is more likely than not to lease the asset;
• Each of the liability and asset will be amortised over the period of the lease on similar bases to those currently required for finance leases;
• Contingent rentals and residual value guarantees should be included within the balance sheet asset and liability, based on the expected value of payments;
• There should be a reassessment of the balance sheet asset and liability at each reporting date.

Their proposals for lessor accounting are beginning to take shape, but remain less definite at this stage:

• The balance sheet to show assets for the ownership of the asset and also for the amounts receivable from the lessee, together with a liability for the performance obligation to allow the lessee use of the asset;
• The initial measurement of the asset in respect of amounts receivable from the lessee should be the present value of those amounts. It seems likely that subsequent measurement will be on the amortised cost basis using an effective interest approach;
• The initial measurement of the liability in respect of the performance obligation should equal the value given to the amounts receivable from the lessee and the subsequent measurement of this liability should reflect the decrease in the lessor’s obligation to permit the lessee to use the asset;
• The lessor should not be permitted to recognise revenue at the start of a lease;
• The treatment by the lessor of lessee options and contingent rentals should mirror those for lessees.

The developments that will take place over the next few months will be important to lessors in terms of the attractiveness of leasing as a product with lease structures, profit recognition and capital requirements all being heavily affected by the outcome.

For more detail on the issues covered by this report please contact George Tonks on +44 (0)845 003 1000 or e-mail: george.tonks@invigors.com.

IASB/ FASB proposals to put all leases on balance sheet

In late March the IASB and FASB finally issued their joint discussion paper on leases, aimed at removing the current “off-balance sheet” treatment of operating leases for lessees. This is the first formal step towards a new accounting standard, to be in place by mid 2011. There are some areas where the two Boards differ in their views on the detail and these will need to be resolved before a common standard can be issued. The paper does not address lessor accounting, which will be considered in the future.

Under the current accounting standards (IAS17 and FAS13, as well as SSAP21), leases are divided between finance (or capital) and operating leases, with no asset or liability appearing on the lessee’s balance sheet for an operating lease. These new proposals will abolish that distinction and require lessees to recognise an asset and a liability on the balance sheet for any lease. The impact for lessees will be increased gearing disclosed on the balance sheet and the need to undertake potentially complex calculations. Consequential impacts will be on the availability of financial facilities and banking covenants.

A study undertaken by the University of Stirling around 10 years ago showed overall gearing as a result of capitalising all leases for their sample of 200 companies increasing by a factor of over 200%, whilst for some individual companies the effects would be even more dramatic. The principal impact comes from property leases, although there can be significant effects for other major assets currently financed on operating leases.

The proposals are that at the start of any lease the lessee should include on its balance sheet an asset and a liability equal to the present value of the minimum lease payments over the lease term, with the lease term being assessed on a “most likely” basis. The asset and the liability would then reduce over the lease term, using an “amortised cost” basis. The discussion paper, which runs to over 100 pages sets out detailed arguments and proposals around lessee accounting, although no clear conclusion in reached on a number of areas of detail.

The overall stance of the European equipment leasing industry is to not disagree with the principles behind the proposals, but to seek to minimise the impact through exclusion of leases that are not material or core to the lessee’s business.

For more information contact George Tonks on +44 (0)845 003 1000 or e-mail george.tonks@invigors.com

Authored by George Tonks

The Credit Crunch and Capital/Gearing

Much has been said in recent weeks about banks raising additional capital as a consequence of the credit crunch. Whilst some of this is to replenish capital eroded through losses, the amounts being raised are typically much higher than the reported losses. In addition, banks have been reducing their lending and other exposures and so reducing their minimum regulatory capital requirements.

The overall effect of the measures taken is that capital ratios generally will be higher in future than they have been over recent years. This reduction in gearing will be felt by asset finance businesses as well, with a direct impact on companies within banking groups and a reduction in the appetite of banks to finance independent companies. For example, a company that has been used to operating with gearing of 9:1 may find that it now has to operate at 6:1. Reduced gearing will then affect profitability in terms of both reported profits and return on equity or economic value added; even reducing these below hurdle rates.

As a consequence all companies in the financial services sector should be reconsidering operating models, margins and expense structures to ensure these are appropriate to delivering financial and other targets. Some business sectors may be uneconomic on current bases, with major restructuring or divestment required. Others may find that third party divestments allow the opportunity to create a financially viable scale operation.

Invigors has the expertise and experience to work with you to reassess your business and to structure it for the new economic climate. To find out more contact George Tonks on +44 (0)845 003 1000 or e-mail george.tonks@invigors.com

Software Leasing – UK tax issues clarified

Over the summer, HMRC have moved to provide further clarification of their position on software financing transactions.  There has been considerable uncertainty of the correct tax treatment of many transactions over recent years, with concern that some transactions could result in tax being paid on considerably more than the economic profit from the transaction.

This historical uncertainty has arisen because of difficulties in translating software transactions into the specific rules set out in the tax legislation.  In particular there are specific tax rules for “intangible assets” and also for claiming tax relief on software “owned” by a lessor through the capital allowances regime, with software brought within this regime provided there is a “right to use or otherwise deal with” it.  This is further complicated by the use of standard leasing terminology for transactions which are not standard leases.

HMRC have now confirmed that, for direct tax purposes, they will seek to ensure that the tax treatment follows the structure of the transaction and allows the tax payable to correspond to the lessor’s economic profit.  Whilst this removes the major concerns around software transactions, HMRC will expect to see transactions classified correctly within tax returns and the appropriate elections submitted, so that a review of existing processes should be made.

If you want to discuss how this announcement from HMRC or other tax issues affect your leasing/ financing transactions and the implications for structuring of transactions please contact George Tonks on 0845 003 1000 or e-mail george.tonks@invigors.com.

New accounting standard for leasing looms into view

Those involved in the leasing industry will be well aware of the “off-balance sheet finance” debate, with finance leases appearing on customers’ balance sheets but not operating leases.  Accounting standard setters have been concerned for many years that this allows some lessees to exclude significant liabilities and assets which are fundamental to their businesses from their balance sheets.  Proposals were originally floated in 1996 to remove off-balance sheet financing through operating leases, although these were not progressed.

In 2007 the International Accounting Standards Board and the US Financial Accounting Standards Board announced a joint project to develop a revised standard for lease accounting.  The project is timed to link with the proposed adoption of International Accounting Standards within the USA from 2013, which requires official acceptance of those standards by 2011.  The project team is on track to produce a formal discussion paper in late 2008 on proposals for a new standard, moving to an exposure draft of the new standard by 2010 before its final adoption in 2011.  In order to meet this timetable, the IASB and FASB have accepted that the new standard should only cover lessee accounting as they perceive this as their major concern, with lessor accounting to be addressed in a subsequent standard some time after 2011.

Whilst the leasing industry does not consider this process is appropriate, it is unlikely that the IASB/ FASB will be deflected from their target. Having completely separate lessor and lessee standards will create difficulties for companies with headlease/ sublease structures and the absence of a revised lessor accounting standard will perpetuate the problem of profit recognition, with many profitable leases still showing losses in early years. 

The likely removal of off-balance sheet treatment for what are currently operating leases may of itself make such leases less attractive to some customers, although this is not an argument that is likely to find favour with the accounting standards setters.  Lessors’ reactions to this development will vary, as some use “off-balance sheet” to promote sales of their leases (although they should now be more cautious on this) whereas others only refer to it in passing. 

Also of concern to the industry is the risk that the calculations required to determine how much should be brought onto the balance sheet may be so complex that customers find leasing less attractive than simpler loan products. 

Given these issues the industry needs to be engaged with the accounting setters to try to arrive at a sensible solution.

To discuss the issues raised in this article and the impact on your business please contact George Tonks on +44 845 003 1000 or e-mail george.tonks@invigors.com

UK Government “consults” on tax changes

Various tax changes affecting leasing and other companies were announced in the March 2007 Budget. Most of these, including the reduction in the main rate of corporation tax from 30% to 28% with effect from 1 April 2008, are included in the Finance Act 2007, which became law in July. However, the proposed changes to capital allowances, which are due to take effect from April 2008, are the subject of a consultation paper issued by HM Revenue & Customs and HM Treasury on 26 July (for comment by 19 October). Whilst it is a consultation paper, much of the information within it simply provides more information on the Government’s intentions, with the consultation element limited to inviting comments on three specific issues. Capital allowances on cars are covered by a separate consultation process, with firmer details expected in October.

The Government intends to reduce the main rate of writing down allowances for plant and machinery from 25% to 20% from April 2008. This is not an issue on which it is consulting and neither are the transitional arrangements. For a company with a year end of 31 March, the rate applied to the plant and machinery capital allowance pools will reduce from 25% to 20% for the year to 31 March 2009. For other companies, there will be a hybrid rate for the period straddling 1 April 2008, using a time apportionment for the length of the periods before and after that date, so that the rate for a 31 December 2008 year will be approximately ¼ x 25% + ¾ x 20% = 21.25% (the final calculation will probably use days rather than months) and then the 20% rate will apply to all assets within the pools for the year ended 31 December 2009.

By contrast, the writing down allowance rate for “long life assets” (those with an expected economic life of over 25 years) will be increased under the proposals from 6% to 10%, with similar transitional arrangements. However, any long life asset acquired from 1 April 2008 will qualify for the full 10% allowance in the year of acquisition.

“Fixtures that are integral to a building” acquired from 1 April 2008 will also go into this 10% allowance pool (and, with long life assets, be excluded from “short life asset” treatment). The Government is inviting comments on how “integral fixtures” should be defined, but proposing that there should be the following short list of items covered by the term:

• lifts, escalators and moving walkways;
• central heating systems; and
• air conditioning systems.

However, it is indicated that electrical and water systems may be added to this list.

The Government is also consulting about the introduction of an Annual Investment Allowance (AIA) for expenditure on plant or machinery, to replace the current First Year Allowances for SMEs. A single AIA for expenditure of up to £50,000 pa will be available to each individual company and to each group of companies.

The third area of consultation is around the introduction of a scheme to enable the current enhanced capital allowances on environmentally beneficial assets to be surrendered for a cash payment, where a company is in tax loss. The aim of this proposal is to reduce the cashflow disadvantage suffered (particularly by small companies) from not being able to benefit from ECAs until the company becomes tax profitable, which could be many years after the expenditure is incurred.

These changes in corporation tax rates and capital allowances will have a significant impact on the asset finance industry, changing the evaluation of new leases and affecting the relative attractiveness of leasing and purchase products. In addition, tax variation clauses in extant leases may be triggered and “sale for tax written down value” clauses and calculations will be affected.

If you would like to discuss the impact of these changes on your business please contact George Tonks  at george.tonks@invigors.com or call +44 (0) 845 003 1000. A longer version of this article is also available on request.

Update on the UK tax regime for leasing and other recent UK tax developments

UK Budget 2007

The UK Budget statement on 21 March introduced a number of tax changes which will have a significant impact on companies involved in UK asset finance. The main headline is that the standard rate of corporation tax will reduce from 30% to 28% from April 2008, although the rate for small companies (those with tax profits of up to £300k) will increase from 20% to 22%. Alongside this, there are substantial changes to the capital allowance regime from 2008/09 for plant and machinery.  In particular:

• the main writing down allowance rate will reduce from 25% to 20%;
• the rate of writing down allowances on “long life assets” (those with an expected life of over 25 years, but excluding railway assets and ships until 2011) will increase from 6% to 10%.  Writing down allowances on fixtures will be brought in line with long life assets. The leasing of long life assets is less common now, following the introduction of the long funding lease rules from April 2006, which restrict lessors’ rights to claim capital allowances;
• a new “annual investment allowance” will be introduced for the first £50k of expenditure on plant and machinery. It appears that this could be equivalent to a 100% first year allowance and could well replace the existing FYAs for SMEs, although the Government has not yet decided on the detail. However, the current 50% first year allowance for small businesses is being extended from April 2007 for a further year;
• there is a further consultation paper on capital allowances for cars, with a proposal that cars emitting up to 165 g/km of CO2 will be brought into the main capital allowance pool (20% WDA) and other cars into another pool with a lower rate of writing down allowances (which is indicated to be at 10%); cars emitting up to 120 g/km will continue to attract 100% FYA. The 165 g/km level is also proposed as the limit above which there will still be a restriction for the tax relief a lessee can claim in respect of rentals. Various aspects of this regime still need to be resolved.

The precise mechanics of implementing these changes is unclear, although they may well apply for the first accounting period ending after 31 March 2008. It appears that the new WDA rate will apply to the whole of the main capital allowance pool as at the implementation date, so including assets acquired prior to that date.

The changes in corporation tax rates and capital allowances will affect lease rental calculations. Overall the changes will typically result in an increase in lease rental rates, although in the short term rentals may fall as early year tax losses can be relieved at 30% whilst later tax profits are taxed at 28%. Tax variation and lease documentation will need to be addressed.

Asset finance companies will also be affected by the extension of the “sale of lessor companies” rules and changes to car VED and company car tax levels.

Electing into the long funding lease regime

Following the introduction of the new leasing tax regime in April 2006, lessors can elect to have leases taxed on the basis of the accounting profits. The Government’s aim is to help lessors avoid the additional administrative burden of preparing separate tax calculations.  However this election can also give benefits to lessors whose leases are for relatively short periods or for leases of plant or machinery that does not qualify for capital allowances. The final Regulations covering such elections have now been published. These confirm that any election will apply to all “eligible” and “qualifying incidental” leases in a company, although a leasing group can be selective by writing leases in separate companies.

Long funding lease rules – the “lease term”

A significant factor in determining whether a lease is a long funding lease under the new tax regime (so that the lessee rather than the lessor is entitled to capital allowances) is the “lease term”. In particular a lease cannot be a long funding lease unless the lease term is in excess of 5 years. The definition of the lease term in the Finance Act 2006 left some areas of doubt about how it should be interpreted and the guidance notes issued by HMRC in August 2006 provided only limited help. Further examples have now been provided by HMRC and it is expected that these will be incorporated into their formal guidance in due course. These provide additional clarification on how HMRC intend to interpret the “lease term” and are helpful for many lessors, particularly those involved in vendor schemes and similar arrangements.

Software

Discussions with HMRC are continuing about the tax treatment of software finance. The latest correspondence from HMRC seems to be designed to provide comfort that providers of software finance will not be left with excessive tax costs, although clarification is still needed on some aspects of the wording. It is hoped that the current uncertainty will be resolved soon.

VAT Bad Debt relief

HMRC have recently changed the calculation of VAT bad debt relief for HP and similar instalment finance agreements. The old “straight line” allocation basis has been accepted by HMRC as inequitable and, under the new rules, the allocation of instalments received from customers for VAT purposes is brought in line with the allocation used for accounting purposes, increasing the amount of bad debt relief available.

For more detail on any of these issues or to discuss the tax position of your leases, contact George Tonks (george.tonks@invigors.com) on 0845 0031000