Determining the Classification of a Land Lease as a Finance or Operating Lease

A Corporation acquires land and provides infrastructure like roads, electricity, water supply etc. for leasing to industries for an initial period of 33 years, with the option of a buy-out after 10 years by paying 20% of the allotment cost or extending the lease up to 99 years. As per para 9 of Ind AS 116, Leases, at the inception of a contract, an entity shall assess whether the contract is, or contains a lease, only when the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

The Corporation is required to account for the land lease in the books of account. The corporation approached the EAC of ICAI to determine whether the lease is categorized as a finance lease or an operating lease.

The Expert Advisory Committee (EAC) of ICAI has noted that the arrangement involves the Corporation conveying the right to use (RoU) the land parcel to the lessee for a specified period of time, i.e., 33 years, in exchange for consideration. During the course of the lease period, the lessee has the right to substantially all of the economic benefits from the use of the land, therefore, the lease within the scope of Ind AS 116.

Moreover, the committee noted that every lessor classifies each of its leases as either an operating lease or a finance lease. Therefore, the Corporation should make this classification on an individual lease-by-lease basis and not at the general overall level. In the extant case, the exercise price for the option in the lease agreements (which is Nil or 20% of the allotment price, which is equivalent to fair value at the inception of the lease) seems to be lower than the market price at the inception of the lease. Therefore, at the inception of the lease, it appears to be reasonably certain that such an option to buy out will be exercised by the lessee.

Accordingly, the Committee is of the view the lease appears to satisfy the tests laid down in Ind AS 116 and hence, should be classified as finance lease by the Corporation.

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