REVENUE MEMORANDUM CIRCULAR NO. 46-2014 issued on May 30, 2014 clarifies the taxability of financial lease for purposes of Documentary Stamp Tax (DST).
Revenue Regulations No. 9-2004 defines Financial Leasing as a mode of extending credit through a non-cancellable lease contract under which the lessor purchases or acquires, at the instance of the lessee, machinery, equipment, motor vehicles, appliances, business and office machines, and other movable or immovable property in consideration of the periodic payment by the lessee of a fixed amount of money sufficient to amortize at least 70% of the purchase price or acquisition cost, including any incidental expenses and a margin of profit over an obligatory period of not less than two (2) years during which the lessee has the right to hold and use the leased property with the right to expense the lease rentals paid to the lessor and bear the cost of repairs, maintenance, insurance and preservation thereof, but with no obligation or option on his part to purchase the leased property from the owner-lessor at the end of the lease contract. A finance lease is a lease that transfers substantially all the risks and rewards incident to ownership of an asset. Title may or may not eventually be transferred.
Based on the foregoing definition of a Financial Lease, the same is akin to a debt rather than a lease. Financial Lease is not only akin to an obligation by definition but also by treatment.
The International Accounting Standard (IAS) on Leases (IAS 17) requires that a liability be set up in the lessee’s books of accounts. Paragraph Nos. 21 and 22 of IAS 17 Leases provides:
“21 Transactions and other events are accounted for and presented in accordance with their substance and financial reality and not merely with legal form. Although the legal form of a lease agreement is that a lessee may acquire no legal title to the leased asset, in the case of finance leases the substance and financial reality are that the lessee acquires the economic benefits of the use of the leased asset for the major part of its economic life in return for entering into an obligation to pay for that right an amount approximating, at the inception of the lease, the fair value of the asset and the related finance charge.
22 If such lease transactions are not reflected in the lessee’s balance sheet, the economic resources and the level of obligation of an entity are understated, thereby distorting financial ratio. Therefore, it is appropriate for a finance lease to be recognized in the lessee’s balance sheet
both as an asset and as an obligation to pay future lease payments.
At the commencement of the lease term, the asset and the liability for the future lease payments are recognized in the balance sheet at the same amount except for any initial direct costs of the lessee that are added to the amount recognized as an asset.”
Although documents, transactions or arrangement under financial lease are not specifically mentioned under Section 179 of the National Internal Revenue Code (NIRC), as amended, the imposition of the DST under such Section of the NIRC, as amended covers all debt instruments. Therefore, being a nature of an obligation, financial lease is covered under such Section of the NIRC, as amended.
Accordingly, any document, transaction or arrangement entered into under financial lease is subject to the DST under Section 179 of the NIRC, as amended.