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Massachusetts DOR characterizes ASC 842 leases as intangible assets
January 2023
In brief
Pursuant to ASC 842, the Finance Accounting Standards Board (FASB) mandates that all leases with a term longer than one year be capitalized.
The Massachusetts Department of Revenue on January 5 issued guidance providing that leases subject to ASC 842 should be characterized as intangible assets for purposes of the non-income measure of the corporate excise.
The takeaway: Massachusetts’ reliance on GAAP as a basis for determining the classification of assets and liabilities for purposes of the Massachusetts non-income measure of the corporate excise can result in shifts in a taxpayer’s net worth when GAAP rules change even though there has not been an underlying change in the taxpayer’s value. For example, ASC 842’s requirement to classify “right-of-use assets” as intangible assets and lease liability as liabilities on a lessee’s balance sheet can result in a change in the calculation of a taxpayer’s allocable net worth to the extent there is a difference between the value of the right-of-use asset and the value of the lease liability. Similarly, the inclusion of right-of-use assets as intangible assets on a balance sheet can increase the denominator that is used in determining whether a taxpayer should be classified as a tangible or intangible property corporation. Taxpayers with considerable right-of-use assets on their balance sheet may wish to consider the Massachusetts tax implications of the ASC 842.
In detail
FAS 842
The FASB, pursuant to FAS 842, requires privately-held companies and nonprofit organizations to capitalize all leases with a term longer than one year.
FAS 842 defines as lease as a “contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.”
Control over the use of the identified asset requires “(1) the right to obtain substantially all of the economic benefits from the use of the asset and (2) the right to direct the use of the asset.”
ASC 842 requires lessees to recognize lease assets (the right to control the use of identified property, plant, or equipment for a period of time) and lease liabilities (payments made in consideration for the right to control the use of the asset) for both capital and operating leases with a term over one year on their balance sheets.
Non-income measure of the corporate excise
The Massachusetts corporate excise consists of an income measure and a non-income measure. The calculation of the non-income measure differs depending upon whether a corporation is classified as a “tangible property corporation” or an “intangible property corporation.”
A “tangible property corporation” is one whose tangible property situated in the Commonwealth and not taxed locally is equal to 10% or greater of its total assets. For such a corporation, the non-income measure is based on the book value of the corporation’s tangible property situated in the Commonwealth.
An “intangible property corporation” is one whose tangible property situated in the Commonwealth and not taxed locally is equal to less than 10% of its total assets. For such a corporation, the non-income measure is based on the corporation’s net worth.
Leases classified as intangible property
The classification of leases as tangible or intangible property may impact whether a business corporation is subject to the property measure or the net worth measure of the corporate excise.
The Department notes that prior Appellate Tax Board decisions determined that the Massachusetts Legislature incorporates Generally Accepted Accounting Principles (GAAP) into the characterization of an asset as tangible or intangible.
Current GAAP rules indicate that all leases should be considered intangible assets. ASC 842 distinguishes between “right-of-use assets,” which are assets that represent a lessee’s right to use an underlying asset for the lease term, and the underlying asset itself, which is the subject of a lease for which a right to use that asset has been conveyed to a lessee. While the underlying asset may be tangible property, it is the right-of-use asset which must be recognized on the lessee’s books. Because the right-of-use asset is merely the contractual right to control the underlying asset, it has no physical existence and is itself intangible.
Additionally, the Department draws support from the fact that it is possible for a lease to be a liability on the lessee’s balance sheet if the payments owed under the lease exceed the value of the right to control the property. Because tangible property cannot be a liability, this further suggests that leases are intangible property.
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