PwC Real Estate Leasing* *connectedthinking

Slide 2 19 October 2005 Real Estate Leasing PricewaterhouseCoopers Content 1. Accounting  Dan Marinescu, Senior Tax Consultant PricewaterhouseCoopers 2. Tax  Richard Grotendorst, Tax Manager PricewaterhouseCoopers 3. VAT  Diana Coroaba, VAT Manager, PricewaterhouseCoopers

PwC Real Estate Leasing* Accounting *connectedthinking Dan Marinescu – Senior Tax Consultant

Slide 4 19 October 2005 Real Estate Leasing PricewaterhouseCoopers Operating Lessor Accounting Rental Income  Recognise on straight-line basis over the lease term  Unless some other systematic basis is more representative of the time pattern in which the benefit derived from the leased asset is diminished Costs  Costs, including depreciation, incurred in earning the lease income are recognised as expenses  Depreciation allocated on a systematic basis consistent with the lessor's policy for similar assets  Initial direct costs (e.g. legal fees) on an operating lease Defer orRecognise

Slide 5 19 October 2005 Real Estate Leasing PricewaterhouseCoopers Operating Lessee Accounting Rental expenses  Recognise on straight-line basis over the lease term  Unless some other systematic basis is more representative of the time pattern of the lessee’s benefit Costs  Costs for services, maintenance and insurance are recognised as expense when incurred Investment property under IAS 40  A real estate property interest held under operating lease can be classified as investment property  Property interest is accounted for as finance lease  The fair value model must be adopted  Provided the Real Estate property is held for capital appreciation or to earn lease rentals

Slide 6 19 October 2005 Real Estate Leasing PricewaterhouseCoopers Finance Lessee Accounting Recognises the asset and the lease obligation on balance sheet at the lower of the present value of the minimum lease payments (MLP) and the fair value of the asset Use interest rate implicit in the lease if this is practicable to determine; if not, use lessee’s incremental borrowing rate Initial direct costs incurred by the lessee in securing the lease (e.g. commission and legal fees) are included as part of the recognised asset

Slide 7 19 October 2005 Real Estate Leasing PricewaterhouseCoopers Finance Lessor Accounting Fixed Asset Receivable = MLPs from the lessor’s point of view + unguaranteed residual – unearned finance income Net investment in the lease Gross investment in the lease

Slide 8 19 October 2005 Real Estate Leasing PricewaterhouseCoopers Summary Balance SheetIncome Statement Finance Lease - LesseeAsset Lease Obligation Accumulated Depreciation Reduction in Lease Obligation Finance Charge Depreciation Expense Finance Lease –LessorReceivable Reduction in Receivable Finance Income Profit/Loss on Sale Operating Lease -LesseeN/ARental Expense Operating Lease - LessorAsset Accumulated Depreciation Rental Income Depreciation Expense

Slide 9 19 October 2005 Real Estate Leasing PricewaterhouseCoopers Leases involving land and buildings Need to consider land and buildings individually Land  in principal operating lease (unless title passes ) Buildings  decide whether finance or operating lease Under IAS 17 MLP allocated between Land & Buildings (L&B) (Separate measurement is not required if land is immaterial or lessee’s interest in L&B are classified as an investment property)

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Complex issues  Subleases  Sale and leaseback  Linked transactions  Lease and leaseback  Leases between related parties  Sale and leaseback with special purpose entities

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Sale and Leaseback Sale of Real Estate by the vendor followed by leasing of the same asset to the vendor Finance LeaseOperating Lease Sales proceeds 100 Carrying amount(80) 20 Defer and amortise over lease term Sale price = FV  Recognise any profit or loss immediately Sale price > FV  Defer and amortise excess over period of asset use Sale price < FV  Recognise profit or loss immediately  If loss compensated by lower future lease payments at below market price defer and amortise it in proportion to the lease payments

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Linked transactions Leases between related parties  True economic substance of the transaction prevails over the legal form  Transactions frequently not conducted at arms length terms  criteria for an operating leaseback may not be met Lease and leaseback  Lease accounting based on the substance of risks and rewards  Up-front lease payment followed by leaseback for shorter periods with annual rental payments  Option to extend the lease Finance arrangement

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Sale and lease back with special purpose entities  Involves the transfer and leaseback of an asset by the seller, to a special purpose entity (lessor) wholly or partly funded by bank borrowings or debt securities  Accounting treatment of such transactions is complex  Seller could de-recognise the asset unless control substantially all the risks and rewards of the asset

PwC Real Estate Leasing* Taxation Richard Grotendorst - Tax Manager Real Estate Leasing* Taxation Richard Grotendorst - Tax Manager *connectedthinking

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Definition under Fiscal Code Finance lease Art. 7 (7) FC A lease whereby at least one of the following conditions is met:  The risks and benefits of the ownership of the leased property are transferred to the lessee upon inception of the leasing contract.  The leasing contract expressly provides for the transfer of ownership of the goods subject to leasing to the user upon expiry of the contract.  The leasing term covers at least 75% of the useful life of the leased property (including any extensions of the lease term). Operating lease Art. 7 (8) FC Any leasing contract that does not fulfill the conditions to be classified as a finance leasing.

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Fiscal Aspects Financial lease  The asset is depreciated by the lessee.  The interest expenses are deducted by the lessee.  The building/land taxes are paid by the lessor.  Insurance premiums are paid as agreed between the lessor and the lessee.  Fx gains (losses ) are taxable (deductible). Operating lease  The asset is depreciated by the lessor.  The lessee deducts the lease instalments.  The building/land taxes are paid by the lessor.  Insurance premiums paid as agreed between the lessor and the lessee.

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Interest deductibility Two deductibility criteria: 1.Limitation of interest expense  Loans from non-financial institutions (e.g. group companies)  Limits: - NBR reference interest rate (RON) - 7% (foreign currency)  Non-deductible interest cannot be carried forward 2.Thin capitalisation rules (debt to equity 3:1)  Interest and foreign exchange differences (debts > 1 year)  Non-deductible interest can be carried forward !The criteria are not applicable to leasing companies (leasing operations only) and to finance leases

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Tax Depreciation (1)  finance leasing - lessee is the owner Depreciation of the asset at the level of the lessee  operating leasing - lessor is the owner of the leased asset Depreciation of the asset at the level of the lessor  ! The general depreciation rules apply for leasing operations

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Tax Depreciation (2)  Difference between accounting and tax depreciation  Based on useful lives stated in the Catalogue of Fixed Assets: Buildings (40 – 60 years), technical equipment (commonly years), office equipment (2 - 6 years) Land is not depreciable, but costs for land modernisation depreciable (10 years).  Depreciation methods: straight-line (buildings), accelerated, reducing balance  Complex assets (e.g. buildings) may be depreciated by subcomponents  Valuation report by an independent appraiser recommended  For assets acquired after having been partially utilised, useful life could be determined by technical experts  Revaluations are not recognised for fiscal purposes after 1 January 2004

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Leases vs. Rental  Rental contracts have similar profit tax treatment as operating leases  Financing costs are fully tax deductible under leases as no thin capitalisation rules apply and there are no other limitations  Limitation of tax deductibility of financing costs for pure rental operations financed by loans granted by other entities (either group companies or not) or shareholder’s loans based  No option right of tenant to purchase the real estate or minimum value of rented property required as opposed to leases  The rental period could be less than one year while the period of the lease contracts exceeds one year  No authorisation or computation method are required for rental agreements

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Other tax issues  Cross-border leasing – Non-resident owners of Romanian Real Estate Real Estate leased to residents and Permanent Establishment’s of non-residents Real Estate leased to non-residents Potential WHT implications  Local taxes – payable by the owner of the leased asset Land tax – fixed amount per sqm depending on the location Building tax - 0.5% to 1% of the building’s value or, if not revalued, between 5-10%

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Potential legislative amendments?  Fiscal Code  Specific provisions as regards Real Estate leasing (operating vs. finance lease)  Tax depreciation of Real Estate investments.  Tax incentives (investment allowance, re-investment reserve).  Law 332/2001 on direct investments with significant impact on the economy  Real Estate leasing to be included.  GO 51/1997 on leasing operations  Define sub-lease.  Establishes a regulatory body on the leasing market.

PwC Real Estate Leasing* VAT Diana Coroaba - VAT Manager *connectedthinking

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Leasing-Real Estate Current treatment  Subject to VAT EU Accession  Exempt with option to tax  Option to tax the leasing => Mandatory taxation of any subsequent transaction (?!)

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Financial leasing Current treatment  VAT on principal  Interest not subject to VAT EU Accession Option to tax  VAT on installments (principal + interest)

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Adjustment period Twenty years starting:  from 1 January of the year during which the right to deduct arises, for the construction, purchase, transformation (20%) or improvement (20%) of a building  from 1 January of the year during which the building was first used

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Adjustment method  The adjustment is made once only for the whole period of adjustment still to be covered  The adjustment should be performed on an yearly basis in case the destination of the building is changed from taxable to exempt operations or vice-versa

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Examples of one - off adjustment - 20 years -

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers A leasing company purchases a building on 15 December 2007 for the price of RON incl. VAT (19% = RON). It deducts RON. It uses the building for operations with a right to deduct.On 2 February 2009, the company concludes a leasing contract for the building. It does not opt to tax the operation and therefore the leasing will be exempt without a right to deduct. Solution  Year 1 (2007) is taken into consideration  Year 2 (2008) is taken into consideration  The loss of the right to deduct VAT appears in year 3 (not taken into consideration) Adjustment in favour of the State: RON x 18/20 th = 1026 RON to be paid Example 1

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Example 2 A leasing company purchases a building in 2007 for the price of RON incl. VAT (19% = RON). It knows it will use the building for exempt operations (i.e. leasing) and does not deduct the input VAT. The company concludes a leasing contract for the building for 5 years starting with 2007 and does not opt for taxation. In 2012, the leasing company concludes a new leasing contract with another beneficiary for the next 15 years.

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Solution  In 2007 the company is not entitled to deduct the input VAT  In 2012 the company leases the building and opts to tax the leasing => The company must adjust the initial input VAT  The right to deduct VAT appears in year 5 (not taken into consideration) Adjustment in favour of the Company: RON x 16/20 th = RON Example 2

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Example 3 A leasing company purchases a building in 2007 for the price of RON incl. VAT (19% = RON). It knows it will use the building for exempt operations (i.e. leasing) and does not deduct the input VAT. The company concludes a leasing contract for the building for 8 years starting with 2007 and does not opt for taxation. In 2015, the leasing contract expires and the leasing company decides to sell the building and tax the transaction. The sell price will be, due to unfavourable market conditions, RON incl. VAT (19% = 950).

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Solution  In 2007 the company does not deduct the input VAT  In 2015 the company sells the building and opts to tax the transaction => The company must adjust the initial input VAT  The right to deduct VAT appears in year 9 (not taken into consideration) Adjustment in favour of the Company: RON x 12/20 th = RON, however the deduction is limited to x 19% = 950 RON ( the output VAT charged on sale) Example 3

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Compliance Main requirements:  The taxable person must keep a list of the capital goods subject to VAT adjustment allowing the control of all tax deducted and adjustments made  This list must be kept during a period of five years after the end of the adjustment  Any other records, documents and books relative to capital goods must be kept during the same period

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers In addition:  More information will be included in the VAT return  No longer – standard sales & purchase ledgers  Quarterly recapitulative statements for intra-Community deliveries and acquisitions

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Possible case scenarios after Accession

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers 2 operations:  Leasing – service: Taxable (option) VAT on each installment (principal and interest)  No input VAT adjustment  Local supply of immovable goods at the end of the leasing contract (if option exercised): Mandatory taxation (?!) VAT on the sale price ROMANIAN LEASING COMPANY ROMANIAN CLIENT Leasing with option to tax Delivery of goods

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers  Leasing – service: VAT exempt  Leasing company must adjust the input VAT initially deducted in relation to the building, if any  One – off adjustment method ROMANIAN LEASING COMPANY ROMANIAN CLIENT Leasing without option to tax

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers  Foreign leasing company pays Romanian VAT on acquisition if the immovable property is a new building  Leasing – service: VAT exempt  Foreign leasing company does not have to register for VAT purposes in Romania  FOREIGN LEASING COMPANY ROMANIAN CLIENT Leasing without option to tax Romanian supplier Acquisition of new building (VAT)

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers  Foreign leasing company pays Romanian VAT on acquisition if the immovable property is a new building or if the supplier opts to tax the transaction  Leasing – service:  Taxable  Romanian VAT on each installment (principal and interest)  Foreign leasing company has to register for VAT purposes in Romania and is entitled to deduct the input VAT on acquisition FOREIGN LEASING COMPANY ROMANIAN CLIENT Leasing with option to tax Romanian supplier Acquisition of immovable property (Exempt with option to tax)

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers PricewaterhouseCoopers services  Training  Pre-accession review (included tailored training)  Pre-accession Forum

Slide October 2005 Real Estate Leasing PricewaterhouseCoopers Your worldsOur people © 2005 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers. PwC