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One thing I don't understand from the Economist article: Is there a difference between (a) borrowing money and (b) borrowing land or machinery? If a company ca

by MarkMc 11y ago

One thing I don't understand from the Economist article: Is there a difference between (a) borrowing money and (b) borrowing land or machinery? If a company cannot treat interest as a tax expense would that mean the cost of renting office space is also not allowed?

saryant 11y ago
I'm not an economist, but leasing an asset like land or machinery doesn't allow a company to lever up its balance sheet.
- rahimnathwani 11y ago
  Signing a 25-year lease on a piece of land is very similar to borrowing the money to buy the land. You are right, the 25-year lease probably wouldn't show up on the balance sheet as a liability. This reflects a limitation in how we do accounting (backward-looking value measurement), not an underlying difference in the economic reality.
rjtavares 11y ago
There are rules to decide whether a lease counts as an asset for the company (in which case part of the rent is interest). IFRS states if any of these tests are met, the lease is considered a finance lease: -ownership of the asset is transferred to the lessee at the end of the lease term; -the lease contains a bargain purchase option to buy the equipment at less than fair market value; -the lease term is for the major part of the economic life of the asset even if title is not transferred; -at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset. -the leased assets are of a specialised nature such that only the lessee can use them without major modifications being made. US GAAP has a similar provision.
- rahimnathwani 11y ago
  The accounting rules to classify leases as {financial; operating} exist to prevent companies from disguising financial leverage as operating leverage. They are intended to ensure that the balance sheet represents a true and fair view of the state of the company. They are not (primarily, at least) intended to ensure that companies are taxed appropriately.
  - rjtavares 11y ago
    Yes, but that's because it was irrelevant. The same rule (albeit more enforced) could be used for tax purposes in this case.
    - rahimnathwani 11y ago
      The tax implications are still, and will always be, irrelevant to accounting rules. The purpose of accounting rules (like IFRS, US GAAP etc.) is to ensure that companies' financial statements represent a true and fair view of the state of the company. This objective has nothing to do with tax.
rahimnathwani 11y ago
You are right. There is no meaningful difference. Capital is just one of several things a business needs in order to operate. Singling it out as something which must be added back to profits (before profit tax is calculated) doesn't make much sense. If a government enacted such laws, accounting firms would be quick to respond by creating new tax avoidance schemes. Complicating the tax code wastes brain power.

by MarkMc 11y ago

saryant 11y ago

I'm not an economist, but leasing an asset like land or machinery doesn't allow a company to lever up its balance sheet.

rahimnathwani 11y ago
Signing a 25-year lease on a piece of land is very similar to borrowing the money to buy the land. You are right, the 25-year lease probably wouldn't show up on the balance sheet as a liability. This reflects a limitation in how we do accounting (backward-looking value measurement), not an underlying difference in the economic reality.

rjtavares 11y ago

There are rules to decide whether a lease counts as an asset for the company (in which case part of the rent is interest). IFRS states if any of these tests are met, the lease is considered a finance lease: -ownership of the asset is transferred to the lessee at the end of the lease term; -the lease contains a bargain purchase option to buy the equipment at less than fair market value; -the lease term is for the major part of the economic life of the asset even if title is not transferred; -at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset. -the leased assets are of a specialised nature such that only the lessee can use them without major modifications being made. US GAAP has a similar provision.

rahimnathwani 11y ago
The accounting rules to classify leases as {financial; operating} exist to prevent companies from disguising financial leverage as operating leverage. They are intended to ensure that the balance sheet represents a true and fair view of the state of the company. They are not (primarily, at least) intended to ensure that companies are taxed appropriately.
- rjtavares 11y ago
  Yes, but that's because it was irrelevant. The same rule (albeit more enforced) could be used for tax purposes in this case.
  - rahimnathwani 11y ago
    The tax implications are still, and will always be, irrelevant to accounting rules. The purpose of accounting rules (like IFRS, US GAAP etc.) is to ensure that companies' financial statements represent a true and fair view of the state of the company. This objective has nothing to do with tax.

rahimnathwani 11y ago

You are right. There is no meaningful difference. Capital is just one of several things a business needs in order to operate. Singling it out as something which must be added back to profits (before profit tax is calculated) doesn't make much sense. If a government enacted such laws, accounting firms would be quick to respond by creating new tax avoidance schemes. Complicating the tax code wastes brain power.