Accounting Treatment of GST on Lease Payments Under Ind AS 116

1. Question

A company (hereinafter referred to as “the Company”), a joint venture of M Limited (50%), N Limited (49%), and the Government of Himachal Pradesh (1%), has taken office premises at Delhi on lease from O Ltd. (the lessor) for a term of three years beginning November 1, 2023, at a monthly rent of ₹17.80 lakh plus 18% GST. The lease includes a 5% annual escalation clause, and the Company has also provided an interest-free refundable security deposit of ₹53.40 lakh.

The Company recognised a Right-of-Use (RoU) asset and a lease liability as per Ind AS 116, Leases, by discounting the total monthly lease payments, including the GST component. The Company’s output services i.e. electricity generation are exempt from GST, hence, no input tax credit is available.

During audit, the auditor observed that GST should not form part of lease payments, referring to the ICAI’s Educational Material on Ind AS 116 (January 2020), which clarifies that GST, whether refundable or not should be excluded from the measurement of lease liability and RoU asset.

The Company contended that excluding GST would distort presentation, as it would appear that additional short-term leases exist. It also argued that the Educational Material is recommendatory in nature. This raised the question whether GST component paid on lease payments can be included in the measurement of the Right-of-Use (RoU) asset and lease liability from the lessee’s perspective when input tax credit is not available.

2. Relevant Provisions

Ind AS 116 – Leases

Para 23 – At the commencement date, a lessee shall measure the right-of-use asset at cost.

Para 24 – The cost of the right-of-use asset shall comprise:

(a) the amount of the initial measurement of the lease liability, as described in paragraph 26;

(b) any lease payments made at or before the commencement date, less any lease incentives received;

(c) any initial direct costs incurred by the lessee; and

(d) an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories. The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the underlying asset during a particular period.

Para 26 – At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.

Para 27 – At the commencement date, the lease payments included in the measurement of the lease liability comprise the following payments for the right to use the underlying asset during the lease term that are not paid at the commencement date:

(a) fixed payments (including in-substance fixed payments as described in paragraph B42), less any lease incentives receivable;

(b) variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date (as described in paragraph 28);

(c) amounts expected to be payable by the lessee under residual value guarantees;the exercise price of a purchase option if the lessee is reasonably certain to exercise that option (assessed considering the factors described in paragraphs B37-B40); and

(d) payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.

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