Stock Exchange explains notifiable/connected transaction rules relating to lease transactions of listed issuers adopting HKFRS/IFRS 16

Hong Kong Financial Reporting Standard/International Financial Reporting Standard 16 “Leases” (HKFRS/IFRS 16), which brought about significant changes in lease accounting for lessees, will be effective for annual periods beginning on or after 1 January 2019.

On 28 September 2018, The Stock Exchange of Hong Kong Limited (Exchange) published a set of frequently asked questions (FAQs) providing guidance on the application of notifiable and connected transaction rules relating to lease transactions entered into by listed issuers adopting HKFRS/IFRS 16. 

This client alert summarises the key points of the guidance.

Key features of HKFRS/IFRS 16

First of all, it is important to understand the following key features of HKFRS/IFRS 16 that are relevant to the classification of lease transactions under the notifiable and connected transaction rules set out in Chapters 14 and 14A of the Main Board Rules (or Chapters 19 and 20 of the GEM Listing Rules):

  • HKFRS/IFRS 16 requires a lessee to recognise a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.
  • Lessor accounting requirements remain substantially the same - A lessor continues to classify its leases as operating leases or finance leases, and to account for those two types of leases differently. 

Given the differences between lessee accounting and lessor accounting under HKFRS/IFRS 16, listed issuers adopting HKFRS/IFRS 16 should note that the principles for classifying lease transactions under the notifiable and connected transaction rules differ depending on whether the listed issuer concerned acts as a lessee or a lessor.

Where the listed issuer is a lessee 

Classification of transaction under Main Board Rule 14.04(1)

  • A lease transaction in which the listed issuer acts as a lessee will be regarded as an acquisition of asset under Main Board Rule 14.04(1)(a).
  • The classification of transaction into a finance lease or operating lease under Main Board Rule 14.04(1)(c) or 14.04(1)(d) will not apply where the issuer acts as lessee.
  • The revenue exemption under Main Board Rule 14.04(1)(g) will not apply because the transaction is of a capital nature. 

Size tests computation

  • The asset ratio and consideration ratio are applicable.
  • Numerator  =  Value of the right-of-use asset recognised by the listed issuer (which includes the present value of lease payments) according to HKFRS/IFRS 16

Aggregation of lease transactions with the same party within 12 months

  • There will be no change in the application of the aggregation rules to lease transactions after the listed issuers adopting HKFRS/IFRS 16.

 

Will a lease entered into with a connected person be treated as a one-off connected transaction or continuing connected transactions?

 

  • Depending on whether the lease agreement is:
    • with fixed terms; or
    • a framework agreement for leases over a period of time. 
  • A lease subject to an agreement with fixed terms will be treated as a one-off connected transaction.
  • Leases under a framework agreement will be treated as continuing connected transactions - Annual caps should be set based on the total value of right-of-use assets relating to the leases to be entered into by the listed issuer in each year.

Implications of retrospective application of HKFRS/IFRS 16 to recognise the right-of-use assets arising from existing leases

  • Listed issuers are not required to re-comply with the notifiable or connected transaction rules for leases under fixed terms or framework agreements entered into by the issuers before the adoption of HKFRS/IFRS 16.
  • Where existing leases have been classified as continuing connected transactions, the issuers should continue to comply with the relevant rule requirements.

Sale and leaseback transactions

 

  • If (a) a listed issuer transfers the legal ownership of an asset to Entity X and leases the asset back from Entity X, and (b) the listed issuer has an option to buy back the asset at the end of the lease period, such a transaction will be accounted for as a financing arrangement by each of the listed issuer and Entity X (and not a sale and leaseback transaction) under HKFRS/IFRS 16. 
  • The listed issuer should classify the transaction on the basis that the transfer of the legal ownership of the asset constitutes a disposal of asset by the listed issuer under Main Board Rule 14.04(1)(a).


Where the listed issuer is a lessor

Classification of transaction under Main Board Rule 14.04(1)

  • The classification of a lease transaction into a finance lease or operating lease under Main Board Rule 14.04(1)(c) or 14.04(1)(d) will continue to be relevant for listed issuers acting as lessors after adopting HKFRS/IFRS 16.

Size tests computation

Similar to the existing practice:

  • An operating lease with a connected person will be a continuing connected transaction.  The maximum annual cap (which should be the maximum annual rental income to be received under the agreement) should be used as the numerator for each of the assets ratio, consideration ratio and revenue ratio.
  • For finance lease transactions, the issuer should calculate the percentage ratios for (i) the disposal of the underlying asset and (ii) the provision of financial assistance.

Sale and leaseback transactions

 

  • If (a) Entity Y transfers the legal ownership of an asset to the listed issuer and leases the asset back from the listed issuer, and (b) Entity Y has an option to buy back the asset at the end of the lease period, such a transaction will be accounted for as a financing arrangement by each of the listed issuer and Entity Y (and not a sale and leaseback transaction) under HKFRS/IFRS 16.  
  • The listed issuer should classify the transaction on the basis that:
    • the transfer of the legal ownership of the asset constitutes an acquisition of asset by the listed issuer under Main Board Rule 14.04(1)(a); and
    • the transaction involves provision of financial assistance under Main Board Rule 14.04(1)(e).