Effective Date

The current tax treatment is effective on lease contracts (finance lease contracts) made on and after April 1st, 2008.

Definition of Lease Transaction

A lease is defined as a rental transaction of assets which meets the criteria below. However, the lease defined in the tax treatment does not include a rental transaction of land which does not transfer the title to the land to the lessee and other transactions specified by ordinances.

1. A lease which is non-cancelable for the lease term, or a lease that is similar to that.
2. A lease in which the lessee is able to substantially derive all the economic benefits arising from the leased asset, and the lessee pays substantially all of the costs arising from the use of assets.

Classification for Lease Transaction

The definition of "lease" under the lease taxation is equal to that of finance lease under the lease accounting standard. Therefore, a "lease" defined under the lease taxation is equal to a finance lease defined under the lease accounting standard, and any rental transaction except the lease under the lease taxation is equal to an operating lease under the lease accounting standard.
A rental transaction of land which does not transfer the title to the land is out of scope of the lease defined under the lease taxation. If a rental transaction transfers the title to land to the lessee, that kind of rental transaction is included in the scope and that lease is treated as a lease which transfers the title to the leased asset to the lessee under the lease taxation.
A lease (finance lease) is classified as either a lease (finance lease) which transfers the title of the leased asset to the lessee or a lease which does not. If a lease meets one of the criteria below, that lease is classified as a lease which transfers the title to the leased asset to the lessee.

a. A lease which includes a title-transfer option

A lease grants a lessee an option which transfers the title to the leased asset to the lessee at a nominal price or nil during the lease term or at the end of the lease term.

b. A lease which includes a bargain purchase option

A lease grants a lessee an option which enables the lessee to purchase the leased asset at a significantly advantageous price during the lease term or at the end of the lease term.

c. A lease in which the leased asset is not be able to be discerned from lessee's own assets, or a lease in which only the specific lessee will use leased asset

It is expected that only the specific lessee will use the leased asset for the economic life of the asset, from the standpoint of the type, usage, and location of the leased asset. A leased asset is not able to be distinguished from the other assets.

d. A lease whose lease term is significantly shorter than the legal economic life of the leased asset

A lease term is significantly shorter than the legal economic life of the leased asset (only if it is expected that the short term lease causes substantial tax reduction for the lessee.).
There is no criterion (d) in the lease accounting standard. If a lease term is much shorter than the legal economic life of the leased asset, the lease (a finance lease) is treated as a lease which transfers the title to the leased asset to the lessee under the lease taxation even if that lease does not legally transfer the title to the leased asset to the lessee.
A lease term (finance lease term) should be more than 70% of the legal economic life of the leased asset, if the economic life of the leased asset is less than 10 years. If the legal economic life of the leased asset exceeds 10 years, a lease term should be more than 60% of the legal economic life.

Judgment for Lease Transaction

If a lessee pays the amount that is approximately more than 90% of the acquisition cost of the leased asset during the non-cancelable lease term, that kind of rental transaction meets the criteria that a lessee pays substantially all of the costs arising from the use of the assets. The acquisition cost of the leased asset includes the interest expense for the acquisition of the leased asset, personal property tax, insurance cost, and other additional costs.

Basis of Lease Taxation

A lessor and a lessee would calculate their taxable income by each fiscal year, as if a leased asset were sold or purchased when the leased asset was delivered from the lessor to the lessee.

Depreciation on Leased Assets

A lessee should depreciate its leased asset based on a specified depreciation method, which is called "straight-line depreciation over the lease term". A lessee is required to submit its tax return with a detailed statement for how the lessee calculates the expense recognized as depreciation expense.

※ Under the lease taxation, in principle, a lessee should treat the amount of the total lease payments as the acquisition cost of the leased asset. If a lessee recognizes the leased asset at the estimated purchase price or the present value of the total lease payments in accordance with the lease accounting standard, the lessee is allowed to treat that amount as the acquisition cost. If the amount of the total lease payments includes a residual value of leased asset guaranteed by a lessee, the lessee should exclude that residual value when calculating the depreciable amount.

A lessee is not allowed to account for a leased asset arising from a lease which transfers the title to the leased asset to the lessee in accordance with the straight line depreciation over the lease term. The lessee would depreciate the leased asset over its legal life, using the same depreciation method for the assets the lessee owns.

Lease Payments

A lessee should account for the interest component included in the total lease payments as interest expense. A lessee is allowed to treat that interest expense as tax-deductible in each fiscal period, regardless of whether the lessee recognizes the interest expense using the effective interest method or the straight line method, in which a lessee evenly allocates the interest component over the lease term.
Furthermore, unless leases are material for a lessee, under the lease accounting standard, the lessee is also allowed to account for the total amount of lease payments without allocating that amount between the interest component and the repayment of the liability. If a lessee chooses this accounting method, the lessee would treat the amount of the lease payments as the amount of depreciation expense for a finance lease in which the lease payments are evenly made and do not include any contingent rentals and so on.
If a lessee deducts maintenance costs or other service costs from the total lease payments, the lessee is allowed to treat the maintenance costs or other service costs as tax-deductible.

Tax Treatment for Finance Lease Accounted for in accordance with Accounting requirements for a Rental Transaction

Under the lease accounting standard, there are some cases in which a lessee is allowed to account for a finance lease which does not transfer the title to the leased asset in accordance with the accounting for a rental transaction (off-balance sheet treatment). However, under the lease taxation, such finance leases are still treated as sale/purchase transaction of leased asset (that is, the amount which a lessee recognizes as lease expense under the accounting standard is included in depreciation expense in the tax treatment.). In this case, a lessee is not required to submit a detailed statement for how the lessee calculates the expense recognized as depreciation expense.
For a finance lease in which the lease payments are evenly made and those amounts are equal to the amounts if the lessee depreciated the leased asset using the straight-line depreciation over the lease term, there is no substantial difference from the accounting for rental transactions (off-balance sheet treatment), because the lessee is not required to prepare for the detailed statement for how the lessee calculates the expense recognized as depreciation expense.

Lease Taxation for Lessor

Under the Lease taxation, a lessor should account for leases (finance leases) in accordance with the regulation of deferred payments. In that regulation, a lessor would account for leases as if the lessor provided long term-installment sales. Regardless of whether a lessor chooses any of 3 accounting methods in the lease accounting standard, called "accounting method 1, 2 or 3", there is no difference between the interest revenues and the taxable income calculated based on the regulation of deferred payments. Therefore, a lessor is allowed to apply the regulation of deferred payments in the tax treatment, regardless of the accounting method the lessor chooses.

Treatment for Leased Asset after the Lease Term

A lessor should treat an asset returned from a lessee at the end of the lease (finance lease) as if the lessor newly acquired the returned asset from the lessee. The amount of the acquisition cost should be the fair value of the asset at the point the lessor receives the asset from the lessee. If it is difficult for a lessor to measure the asset at the fair value, the lessor is allowed to use the estimated residual value in the lease accounting standard instead of the fair value.
If a lessee chooses to continuously use the leased asset after the initial lease term (the lease term of a finance lease), the lessor would start to depreciate the leased asset over the estimated economic life of the asset or would depreciate it over the term below. If the depreciable term has a fraction less than 1 year, the fraction would be cut off. If the depreciable term is less than 2 years, the depreciable term should be 2 years.

1. If the initial lease term is longer than the legal economic life of the leased asset, the depreciable life of the returned asset is 20% of the legal useful life.
2. If the initial lease term is less than the legal economic life of the leased asset, the depreciable life of the returned asset is 20% of the initial lease term plus the term calculated by means of deducting the initial lease term from the legal useful life of the leased assets.

Sale and Lease Back Transaction

A sale and leaseback transaction is a transaction in which a lessee sells its own asset to a lessor, and the lessee uses the asset through a lease with the lessor.
Some sale and lease back transactions are regarded as not sale and purchase transactions but loans to a lessee, based on the type of leased asset as well as the situation and the circumstance. If a sale and lease back transaction is regarded as a loan to a lessee, the lessee and the lessor should calculate the amount of the taxable income by each fiscal year, as if there were no a sale/purchase transaction of leased asset, but a loan from the lessor to the lessee.

Transition

A lessee and a lessor should treat lease contracts (finance lease contracts) which were made before April 1st 2008, as rental transactions even after April 1st 2008.