Part H - The treatment of contracts, leases and licences in GFS
Contracts, leases, and licences are treated as non-financial non-produced assets in GFS, and form part of the concept of intangible non-produced assets (ETF 832) in the GFS balance sheet.
The basic function of a contract is to record the terms of agreement for one unit to provide another unit with a good, service, or asset at an agreed price within an agreed time frame. Paragraph A4.2 of the IMF GFSM 2014 states that contracts may take the form of written, legally binding agreements, or they may be informal or even implicit in nature. Whatever form they take, contracts serve as evidence of a change in the ownership of an asset and the point at which a transaction takes place.
The term 'leasing' refers to a contractual arrangement where the owner of an asset (the lessor) allows a second party (the lessee) to use the asset for a specified time in return for payment. There are three types of leases relating to the use of non-financial assets that are recognised in macroeconomic statistics. Paragraphs A4.6 to A4.17 of the IMF GFSM 2014 name these as:
- Operating leases;
- Financial leases; and
- Resource leases.
In GFS, there is a distinction between legal and economic ownership of assets. The legal owner of an asset is defined as the institutional unit entitled by law and sustainable under the law to claim the benefits associated with the asset. By contrast, the economic owner of an asset is entitled to claim the benefits associated with the use of the asset in the course of an economic activity by virtue of accepting the associated risks. The legal owner is often the economic owner as well. When they are different, the legal owner of an asset is said to have divested themselves of the risks in return for agreed payments from the economic owner. When determining the ownership of leased assets, paragraph A4.4 of the IMF GFSM 2014 states:
- In the case of operating leases and resource leases, there is no change of economic ownership of the asset and the legal owner continues to be the economic owner. Resource leases are agreements for the use of natural resources, such as land and radio spectrum. Operating leases are agreements for the use of all other non-financial assets.
- In the case of financial leases, there is a change of economic ownership of the asset: the legal owner of the asset conveys economic ownership to another institutional unit. Financial leases can apply to all non-financial assets, including natural resources under some circumstances.
An operating lease is defined in paragraph A4.6 of the IMF GFSM 2014 as a contract for the renting out of produced assets under arrangements that provide the use of the asset to the lessee, but does not involve the transfer of the bulk of the risks and rewards of ownership to the lessee. The legal and economic owner of assets under an operating lease is called the lessor. One indicator of whether an operating lease exists is that it is the responsibility of the legal owner to provide any necessary repair and maintenance of the asset. Under an operating lease the asset remains on the balance sheet of the lessor. Amounts payable under an operating lease for the use of the asset are referred to as rentals and are recorded as use of goods and services (ETF 1233, COFOG-A, SDC).
Paragraph A4.7 of the IMF GFSM 2014 indicates that operating leases are most commonly used for nonfinancial assets such as motor vehicles, office equipment (e.g. photocopiers), construction equipment, buildings, etc. Under an operating lease arrangement, the lessor takes responsibility for the repair and maintenance and security of the asset. The lessor may also be required to replace the asset if it is seriously damaged. Depreciation on the asset under an operating lease arrangement is recorded in the accounts of the lessor.
A financial lease is defined as a contract under which the lessor (as the legal owner of an asset), conveys all the risks and rewards of ownership of the asset to the lessee. Under this arrangement, the lessor provides an imputed loan which allows the lessee to acquire the risks and the rewards of the asset, but the lessor retains the legal title (ownership) of the asset. The lessor will record a loan (corresponding to the market value of the leased asset) to the lessee on their balance sheet (classified as transactions in financial assets (net) (ETF 3111), finance leases (TALC 431, SDC)), and the lessee will record both the market value of the leased asset and an equivalent loan liability on their balance sheet when the lease is signed, or economic control of the asset changes hands (classified as transactions in liabilities (net) (ETF 3211), finance leases (TALC 531, SDC)).
Paragraph 9.45 of the IMF GFSM 2014 states that when goods are acquired under a financial lease, a change of economic ownership from the lessor to the lessee is deemed to take place, even though the leased goods remain legally the property of the lessor. This change in economic ownership is financed by a loan transaction: the lessor and lessee record a loan equal to the market value of the asset, this loan being gradually paid off over the period of the lease. The implication of treating a financial lease as a loan is that interest accrues on the loan. At the time the lease is initiated, the market value of the imputed loan is, by definition, equal to the market value of the asset (or principal). The rate of interest is the discount rate, which when applied to the future lease payments, matches their present value with the principal. Therefore the lease payments equate to instalments that cover the interest accrued during the period as well as repayment of the principal.
At the end of the lease term, paragraph A4.15 of the IMF GFSM 2014 states that the asset may be returned to the lessor to cancel the loan, or a new arrangement (including the outright purchase of the asset) may be reached between the lessor and lessee. If the lease is for less than the expected economic life of the asset, the lease usually specifies the value to the lessor at the end of the lease or the terms under which the lease can be renewed. Any variation in the price of the asset from the value specified in the lease agreement is borne by the lessee.
There are a number of indicators which may help to distinguish if a contract is in fact a finance lease. These indicators are listed in Box 13.3 below.
Box 13.3 - Evidence that a contract may be a financial lease
Under a financial lease, the lessee becomes the economic owner of the associated non-financial produced asset. Under an operating lease, the lessor remains the economic owner of the non-financial produced asset and payments by the lessee are recorded as payments for a service. Evidence that a contract may be a financial lease includes:
- The lease contract transfers legal ownership of the asset to the lessee at the end of the lease term; or
- The lease contract gives the lessee the option to acquire legal ownership of the asset at the end of the lease term at a price that is sufficiently low that the exercise of the option is reasonably certain; or
- The lease term is for the major part of the economic life of the asset; or
- At inception, the present value of the lease payment amounts to substantially all of the value of the asset; or
- If the lessee can cancel the lease, the losses of the lessor are borne by the lessee; or
- Gains or losses in the residual value of the residual asset accrue to the lessee; or
- The lessee has the ability to continue the lease for a secondary period for a payment substantially lower than market value.
Source: Appendix 4.11, International Monetary Fund Government Finance Statistics Manual, 2014
A resource lease is defined in paragraph A4.16 of the IMF GFSM 2014 as an agreement whereby the legal owner of a natural resource (that macroeconomic statistics treat as having an infinite life) makes it available to a lessee in return for a regular payment. Under a resource lease, there is no change in economic ownership so the resource continues to be recorded on the balance sheet of the lessor, even though it is used by the lessee. The lessee is allowed the use of the natural resource in exchange for regular payments (which are called rents), the receipt of which are recorded as property income by the lessor. By convention, no depreciation is applied to natural resources. The use or depletion of a natural resource is instead recorded as an other change in the volume of assets (see Chapter 11 for more information other change in the volume of assets).
Australian natural resources (including petroleum and gas reserves) are owned by the Commonwealth, state and territory governments. The right to use natural resources may be granted to other parties but the Commonwealth, state and territory governments retain ownership of these assets.
In Australia, one of the most common types of resource lease concerns the leasing of mineral resources. There are three broad types of mining licences and leases issued in Australia. Each corresponds with a certain stage of the mining process and confers particular rights to the licence or lease holder:
- Initial access for exploration and evaluation purposes is granted through prospecting or exploration licences. These licences confer the right to explore and evaluate a specified area of land (both above and below the surface) to determine the existence, quality and quantity of minerals present. In addition, a prospecting licence may grant the right to hand-mine for minerals.
- In the event that exploration is successful but for one reason or another, mining cannot commence, the right to postpone extractive activities is granted through a retention lease.
- In the event that exploration is successful and mining can commence, the right to engage in extractive activities is granted through a mining lease. This right is conferred with respect to discoveries within a defined area and over a specified term. Mining leases in Australia are generally granted for maximum terms of between 20 and 25 years, but it is common for shorter terms to be renewable.
In GFS, licences exist to provide a regulatory function for common activities undertaken by the general population. If the issue of such licences involves little or no work for the government, then the revenues raised are recorded as taxation revenue (ETF 111). However, if the government uses the issue of licences to exercise some sort of regulatory function, such as checking the competency or qualifications of a would-be licensee, then the revenues raised are recorded as administrative fees (ETF 1122) as part of sales of goods and services by government unless they are clearly disproportionate to the costs of providing the services. Examples of licences issued by government include fishing licences, marriage licences, drivers licences, and dog owners licences. Further information on the classification of tax versus payment for services can be found in Box 13.5 of this manual.
The difference between a lease and a licence is that governments issue licences in order to regulate certain activities that are common to the general population, whereas government leases often involve a specialised activity, such as mineral extraction.
Permits to undertake a specific activity
In addition to leases and licences, governments may issue permits that give individuals or entities permission to engage in a particular activity in exchange for a fee. Permits are designed to limit the number of individual units entitled to engage in an activity. Often the government is required to check the competency and / or qualifications of permit holders. If the government performs this type of regulatory function, then the fees that are associated through the issue of permits will be recorded as administrative fees (ETF 1122) as part of sales of goods and services (ETF 112). Examples of permits issued by governments include gambling permits, food and beverage permits, and taxi-plate permits.
Determining whether a licence represents the sale of an asset or rent from natural resources
Sometimes it can be difficult to determine whether payments received under certain licensing arrangements actually constitute the sale of an asset, or whether they represent rents received from natural resources under Box A4.1 of the IMF GFSM 2014 lists a number of criteria designed to determine whether payments received under a licence represent an asset sale or rent from natural resources. These criteria have been reproduced in Box 13.4 below:
Box 13.4 - Criteria used to determine whether a licence represents an asset sale or rent from natural resources
- Costs and benefits assumed by licensee: the greater the extent of the risks and benefits associated with the right to use an asset incurred by the licensee, the more likely the classification of a transaction as the sale of an asset as opposed to rent. Pre-agreement on the value of payments (whether by lump sum or by instalments) effectively transfers all economic risks and benefits to the licensee and points therefore, to the sale of an asset. If, on the other hand, the value of payment is contingent on the results from using the licence, risks and benefits are only partially transferred to the licensee and the situation is more readily characterised as payment of rent. In the case of mobile phone licences, the total amount payable is often pre-agreed. An additional indication of the degree to which commercial risks have been passed to the licensee is to examine the hypothetical case where a licensee goes bankrupt. If, in such a case, the licensor reimburses none of the up-front payment made by the licensee, this would constitute a strong case against a characterisation of the transaction as rent, as apparently the licensee has incurred all the risks involved.
- Up-front payment or instalment: as with other indicators, the mode of payment is in itself not conclusive for a characterisation as a transaction in assets or rent payment. Generally, the means of paying for a licence is a financial issue and not a relevant factor in determining whether or not it is an asset. However, business practice shows that up-front payments of rent for long periods (15-25 years in the case of mobile phone licences) are unusual and this favours an interpretation as sale of an asset.
- Length of the licence: licences granted for long periods suggest the transaction should be treated as the sale of an asset, for shorter periods a treatment as payments for rent. The time frame involved in mobile phone licensing (15-25 years) is considered rather unusual as a period for which to conclude a fixed payment of rent and therefore a further indication favouring an interpretation as sale of an asset.
- Actual or de facto transferability: the possibility to sell the licence is a strong indication of ownership and if transferability exists, this is considered a strong condition to characterise the licensing act as the sale of third-party property rights. In practice, mobile phone licences are often transferable either directly (by the corporation selling the licence to another corporation) or indirectly (through the corporation being acquired through a takeover).
- Cancellation possibility: the stronger the restrictions on the issuer’s capacity to cancel the licence at its discretion, the stronger the case for treatment as a sale of an asset. Conversely, when licences can easily be cancelled at the discretion of the issuer, ownership over benefits and risks has not been fully transferred to the licensee and the transaction qualifies more readily as rent.
- Conception in the business world and international accounting standards: businesses, in accordance with international accounting standards, often treat a licence to use the spectrum as an asset. Again, in itself this does not lead to treatment as an asset in the national accounts, and there are other areas where companies choose to present figures in their accounts in ways that are not consistent with the national accounts. But the treatment of the acquisition of mobile phone licences as capital investment in company accounts provides an added incentive to treat them in a similar way in the national accounts.
Note that not all, or the majority of these considerations have to be satisfied to characterise the licence as a sale of an asset. However, to qualify as rent of a natural resource asset (rather than the sale of an asset), at least some of the following conditions should hold:
- The contract is of short-term duration, or renegotiable at short-term intervals. Such contracts do not provide the lessee with a benefit when market prices for the leased asset go up in the way that a fixed, long-term contract would. Such benefits are holding gains that typically accrue to owners of assets.
- The contract is non-transferable. Non-transferability is a strong but not a sufficient criterion for the treatment of licence payments as rent, because, although it precludes the lessee from cashing in on holding gains, it does not preclude the lessee from reaping comparable economic benefits (e.g., using the licence in their business).
- The contract contains detailed stipulations on how the lessee should make use of the asset. Such stipulations are often seen in cases of rent of land, in which the owner wishes to retain control over the usage of the land. In the case of licences, examples of such stipulations would be that the contract states what regions or types of customers should be served, or that it sets limits on the prices that the lessee may charge.
- The contract includes conditions that give the lessor the unilateral right to terminate the lease without compensation, for instance for under-use of the underlying asset by the lessee.
Source: Box A4.1, International Monetary Fund Government Finance Statistics Manual, 2014.