Changes in IFRS Lease Accounting Potential Tax Consequences

1. Changes in IFRS Lease AccountingPotential Tax Consequences Wolfgang Griesbach, Tax Partner – KPMG Germany

2. Lease Taxation in Germany - Background • Lease taxation follows the substance over form principle • Basis in tax law is § 39 General Tax Code as interpreted by • the Federal Tax Court (in 1970), and based thereon • the Ministry of Finance in four general letter rulings issued in 1971 and 1972 (full-pay-out-leases) and 1975 and 1991 (non-full-pay-out-leases). • The description below of German lease taxation relates to movable and immovable property. Similar principles can be applied to intangibles. • The rules are identical for income tax and VAT.

3. Lease Taxation in Germany - Principles • Decisive factor is the economic ownership test, • not • the question of finance lease or operating lease • Relevant factors for this test are: • Legal ownership of the asset • Non-cancellable lease term (40% / 90% test) • Full-pay-out vs. non-full-pay-out during this term • Upside chance and downside risk / end of term options The view of lessor´s tax office finally prevails

4. Lease Taxation in Germany – Current status (Lessor) • Economic ownership resides with the lessor • Rental agreement, rents represent taxable income • Lessor records the asset and can claim depreciation • Lessor can deduct refinancing interest (subject to earning stripping rules from 2008 onwards and restrictions for trade tax) Economic ownership resides with the lessee • Sale and financing agreement • Lessor records a receivable from the “sale” at asset cost • Interest portion of lease rentals represent taxable income • Lessor can deduct refinancing interest (subject to earning stripping rules from 2008 onwards and restrictions for trade tax)

5. Lease Taxation in Germany – Current status(Lessee) • Economic ownership resides with the lessor • Rental agreement, rents represent taxable expense • Restrictions for trade tax on income (5% / 6,25% / 18,75% of rent is not deductible from 2008 onwards) Economic ownership resides with the lessee • Sale and financing agreement • Lessee records the asset at cost and can claim depreciation • Lessee records liability at the same amount • Rental payments are split into interest and debt repayment • Lessee can deduct interest portion (subject to earning stripping rules from 2008 onwards and restrictions for trade tax)

6. Lease Taxation in Germany – Dependencies on Accounting • Accounting treatment as basis for the tax treatment is a basic principle in German tax law (§ 5 Income tax code) • German GAAP as the relevant source • Numerous exceptions from this principle • International accounting standards are basically not used • New earning stripping rules are referring to IFRS for equity quote comparison • Due to the absence of specific leasing rules in German GAAP the tax rules determine the German GAAP.

7. Lease Taxation in Germany – accounting changes • There have been some announcements / discussions to reform the existing tax leasing rules, but nothing happened • During such discussions the idea to adjust the tax leasing rules to international standards and via this also change the German GAAP has been picked up, but was dropped very quickly • A change of tax leasing rules and by this also the accounting rules seems to be currently not a topic by German (tax) authorities

8. Lease Taxation in Germany – Options for change • To give up the principle tax follows accounts? • This would require a separate set of rules for all taxpayers, not only for the leasing industry • Could be an option when IFRS “light” is coming • Leaves tax basis under German authorities´control • Tax continue to follow accounts? • Maintain the existing principle • Restrict IFRS to consolidation • Bottom line: • It seems to be unlikely that tax would follow accounting changes