Under FRS 102, bringing a lease onto the balance sheet does not by itself create deferred tax. Section 29 only recognises deferred tax on timing differences, and HMRC generally allows a lessee to deduct the depreciation and interest charged in the accounts in the same period. Deferred tax arises on leases only where tax relief comes in a different period from the accounting charge: mainly transitional adjustments that the tax rules spread over several years, long funding leases where the lessee claims capital allowances, and some capital elements of the right of use asset.

Why is deferred tax on leases different under FRS 102 and IFRS?

FRS 102 paragraph 29.6 requires deferred tax on all timing differences: differences between taxable profits and total comprehensive income that arise because income and expenses are included in tax assessments in different periods from those in which they are recognised in the accounts. It is an income statement approach. On the day a lease starts, a lessee recognises a right of use asset and a lease liability of the same amount, with no profit or loss entry and no tax entry, so there is no timing difference.

IFRS takes a balance sheet approach. IAS 12 compares carrying amounts with tax bases and, since amendments effective for periods beginning on or after 1 January 2023, paragraph 22A specifically says the initial recognition exemption does not apply to the equal taxable and deductible temporary differences that can arise on a lease at commencement. IFRS reporters therefore recognise deferred tax on both the lease liability and the right of use asset where tax law gives rise to those differences. Copying that approach into FRS 102 accounts is a mistake. The general Section 29 rules are explained in FRS 102 Section 29 deferred tax.

How does HMRC tax a lessee with a right of use asset?

HMRC’s Business Leasing Manual covers this from BLM50000. The key points are:

  • Schedule 14 to Finance Act 2019 was designed so that lessees have no tax advantage or disadvantage from moving to right of use accounting; the only change for tax could be timing differences (BLM50010).
  • For a lease that is not a long funding lease, rentals are revenue expenditure and, where GAAP is correctly applied, an amount equal to the depreciation of the right of use asset and the interest on the lease liability is in most cases deductible in the period it is charged (BLM51005).
  • Some costs capitalised in the right of use asset, such as part of a lease premium or capital dilapidations, may be capital, so the matching part of the depreciation is added back as it is charged (BLM51010).
  • A GAAP compliant impairment of a right of use asset should normally be accepted (BLM51020).

Because the deduction follows the accounts charge for most ordinary leases, the lease itself usually produces no timing difference and no deferred tax.

When do leases create timing differences?

Transitional adjustments spread for tax

Schedule 14 to Finance Act 2019 requires adjustments arising on adopting a standard that introduces right of use assets to be spread for tax over the weighted mean remaining length of the leases giving rise to them, calculated in five steps (BLM52005 and BLM52010). Any amount taken to equity on transition is therefore relieved, or taxed, over several years rather than at once, which is a timing difference that reverses over the spreading period.

HMRC notes in BLM52005 that under FRS 102 such adjustments should be less common than under IFRS 16, because paragraph 1.51(b) generally sets the right of use asset equal to the lease liability, adjusted for prepaid or accrued rent. They still arise, for example where a right of use asset is impaired on transition under paragraph 1.51(c); BLM52035 confirms impairment allowances made on transition are included in the spreading calculation. The calculation is needed only once, for the first period of adoption (BLM52045).

Long funding leases

A lessee of plant or machinery under a long funding lease is treated as owning it and as having incurred capital expenditure on it (section 70A Capital Allowances Act 2001). HMRC’s BLM51035 confirms that a long funding lease accounted for as a right of use asset is taxed as a long funding finance lease. Where capital allowances replace a deduction for depreciation, paragraph 29.8 requires deferred tax when allowances are received before or after the depreciation is charged. See long funding leases.

Capital elements that are never relieved

Depreciation added back because it relates to capital costs with no future relief is a permanent difference. Paragraph 29.10 says deferred tax is not recognised on permanent differences. Where a capital cost does attract relief later, the difference is a timing difference instead.

How does it work with numbers?

Illustration only. A company adopts the revised Section 20 on 1 January 2026. On transition it impairs the right of use asset for a vacated property by £40,000, debited to opening retained earnings. Assume the spreading period works out at exactly four years, so £10,000 of the adjustment is deductible for tax in each of the next four years. The company pays Corporation Tax at the 25% main rate.

Date Adjustment still to be relieved Deferred tax asset at 25%
1 January 2026 £40,000 £10,000
31 December 2026 £30,000 £7,500
31 December 2027 £20,000 £5,000
31 December 2028 £10,000 £2,500
31 December 2029 nil nil

The £10,000 deferred tax asset at transition is credited to retained earnings alongside the impairment, because paragraph 29.22 presents tax in the same component as the transaction that gave rise to it. Each year the £2,500 of current tax relief is matched by a £2,500 deferred tax charge in profit or loss. The asset is recognised only if it is probable it will be recovered (paragraph 29.7).

By contrast, a ten year lease entered into in 2027 with no capital elements produces no deferred tax: the deduction each year equals the depreciation and interest in the accounts.

Which tax rate should be used?

Paragraph 29.12 measures deferred tax at the rates and laws enacted or substantively enacted by the reporting date that are expected to apply when the timing difference reverses. Where different rates apply to different levels of profit, paragraph 29.13 requires the average rate expected to apply. GOV.UK states the main rate is 25% for profits over £250,000 and the small profits rate is 19% for profits of £50,000 or less, with marginal relief between those limits. Paragraph 29.17 prohibits discounting. More detail is in which deferred tax rate to use.

Do small companies and micro entities need to worry about this?

Small companies applying Section 1A follow the full recognition and measurement rules of FRS 102 (paragraph 1A.1), so Section 29 applies to them, although for most of their leases the answer will be that there is no timing difference. Micro entities using FRS 105 do not account for deferred tax and were not moved to the on balance sheet lease model; see why micro entities ignore deferred tax.

Where is lease deferred tax presented?

Paragraph 29.21 presents changes in deferred tax as tax expense or income, and paragraph 29.22 puts that expense in the same component of comprehensive income or equity as the item it relates to, which is why the transitional element above goes to equity. Paragraph 29.23 presents deferred tax liabilities within provisions for liabilities and deferred tax assets within debtors, unless the entity has adapted its balance sheet format under paragraph 4.2A.

What mistakes come up most often?

  • Applying the IAS 12 approach and booking gross deferred tax on the right of use asset and lease liability in FRS 102 accounts.
  • Treating the whole transitional adjustment as deductible in the first year, instead of spreading it under Schedule 14 to Finance Act 2019 and recognising deferred tax on the part not yet relieved.
  • Recognising deferred tax on capital depreciation add backs that will never be relieved.
  • Missing long funding leases, where capital allowances drive the tax and paragraph 29.8 applies.
  • Putting the deferred tax on a transitional adjustment through profit or loss when the adjustment itself went to equity.

For the accounting changes that sit behind all of this, see FRS 102 changes from January 2026.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.