Regulations Amending the Crown Corporation General Regulations, 1995: SOR/2018-220
Canada Gazette, Part II, Volume 152, Number 23
SOR/2018-220 October 29, 2018
FINANCIAL ADMINISTRATION ACT
P.C. 2018-1317 October 26, 2018
Her Excellency the Governor General in Council, on the recommendation of the Minister of Finance, pursuant to subsection 127(4) of the Financial Administration Act footnote a, makes the annexed Regulations Amending the Crown Corporation General Regulations, 1995.
Regulations Amending the Crown Corporation General Regulations, 1995
1 Paragraph 10(b) of the Crown Corporation General Regulations, 1995 footnote 1 is replaced by the following:
- (b) a lease, as described in The Handbook of the Chartered Professional Accountants of Canada, as amended from time to time, to a Crown corporation by a person, partnership or association, if the lease exceeds the lesser of 5% of the total assets of the Crown corporation and $10,000,000;
Coming into Force
2 These Regulations come into force on January 1, 2019, but if they are registered after that day, they come into force on the day on which they are registered.
REGULATORY IMPACT ANALYSIS STATEMENT
(This statement is not part of the Regulations.)
The “IFRS 16 Leases” is an International Financial Reporting Standard (IFRS) set by the International Accounting Standards Board (IASB)footnote 2 that will take effect on January 1, 2019, and will change how certain Crown corporations account for their leases. Amendments to the Crown Corporation General Regulations, 1995 (the Regulations) are necessary to address this change in accounting standards.
New accounting standard: IFRS 16 Leases
Accounting standards are authoritative standards for financial accounting and reporting developed through an organized standard-setting process and issued by a recognized standard-setting body. The Chartered Professional Accountants of Canada (CPA) establishes accounting standards for Canada and has a policy of fully adopting IFRS standards. IFRS standards are the de facto global language of financial reporting, used extensively across developed, emerging and developing economies. The Regulations refer to the CPA Handbook for the definition and financial statement recognition of capital leases.
The IASB, through a joint international working group, has studied how capital leases should be accounted for in a corporation’s financial statements for many years. They conducted extensive analysis, which was informed by consultation on an international scale, on whether or not to recognize the assets and liabilities arising from lease transactions. In January 2016, the IASB concluded that operating leases are off-balance sheet financing of assets and that this approach does not provide shareholders and other users of the financial statements with accurate reporting of lessees’ liabilities. In order to increase transparency, the IASB created a new standard, IFRS 16 Leases, which represents a substantial change in the way IFRS users will be accounting for and reporting leases.
Under the existing IFRS framework, depending on their attributes, leases are classified in financial statements as either (1) capital leases are recorded on the balance sheet as assets with corresponding liabilities; or (2) operating leases where only the lease expense for the year is recorded in the income statement (i.e. the leased asset and its associated liability of future payments do not appear on the balance sheet). Currently, the majority of leases are classified as operating leases rather than capital leases (i.e. leases are currently largely held “off-balance sheet”). Under the new IFRS 16 Leases framework, most leases will be recognized (or capitalized) on the balance sheet as an asset with a corresponding lease liability.
The objective of IFRS 16 Leases is to report information that (a) faithfully represents lease transactions; and (b) provides a basis to assess the amount, timing and uncertainty of cash flows arising from leases. It will require lessees to recognize assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value (less than $5,000). footnote 3
By reporting significant leases that were previously off-balance sheet, both a lessee’s assets and liabilities will increase. These changes will ultimately be reflected in the lessee’s financial condition. footnote 4 Shareholders and other users of financial statements will benefit from this increased transparency under IFRS 16 because it will provide a truer picture of a lessee’s balance sheet.
IFRS 16 Leases is expected to impact most companies (in general). Its adoption and compliance will provide shareholders and the public with more accurate and comparable data and far greater financial transparency on a given entity’s leasing activities than exists at present.
Ministerial oversight of leases
The Minister of Finance is responsible for the overall management of the financial affairs of the Government of Canada, including reviewing and monitoring the impact of Crown corporations’ activities on the fiscal framework and, if required, taking necessary actions to ensure their operations are aligned with the Government’s fiscal priorities. As part of these responsibilities, the Minister of Finance reviews and monitors the funding of Crown corporation activities and provides related approvals for their borrowing transactions.
As leases can represent a material and long-term financial commitment with a payment stream that mimics a long-term debt liability, certain Crown corporation leases are deemed to be borrowing transactions. The Regulations deem a capital lease, as defined by the CPA handbook, to be borrowing transactions for the purpose of Part X of the Financial Administration Act (FAA). Crown corporations subject to Part X (Crown corporations) of the FAA footnote 5 and the Regulations are required to seek the Minister of Finance’s approval of the specific dates, terms and conditions for capital lease transactions if the lease exceeds the threshold (i.e. the lesser of 1% of the total assets of the Crown corporation and $100,000).
The Government of Canada is the sole shareholder of the Crown corporations, guaranteeing liabilities of agent Crown corporations. The Minister of Finance approves Crown corporations’ significant lease liabilities because the liabilities recorded on a corporation’s balance sheet could have an impact on the Government of Canada’s financial position. For example, an increase in liabilities may affect Crown corporations’ financial metrics (e.g. current ratio, debt-to-equity ratio, interest coverage, and operating cash flows) that lenders commonly use to determine loan covenants and cost of borrowing. If these metrics exceed prudent operating ranges, this could affect Crown corporations’ borrowing costs and credit ratings. Since the Government of Canada is the financial backstop for Crown corporations, it could also have an adverse effect on the Government of Canada’s financial position. For example, a change in the perceived solvency of a Crown corporation could affect the Government of Canada’s credit ratings, borrowing costs and ability to borrow in financial markets.
A clear line of sight into significant upcoming lease transactions allows the Minister of Finance to monitor the liabilities and length of time a Crown corporation plans to enter into lease transactions to determine if the transactions align with the Government’s plans for the Crown corporation. For example, if a Crown corporation was flagged for dissolution in the short to medium term, the Minister should know if that Crown corporation was planning to enter into a significant long-term lease, and be aware of any breakage fees and other terms associated with that liability.
Ministerial approval for significant lease transactions also encourages better asset management practices. For example, by having to seek approval, Crown corporations can have economic and strategic motivations to plan for their significant lease transactions. The approval process encourages Crown corporations to negotiate leases in a timely manner so that they can get the best possible terms and conditions. Furthermore, they are more likely to take into consideration upcoming lease liabilities when planning future cash flows.
IFRS 16 Leases and Crown corporations
The majority of Crown corporation leases have historically been classified as operating leases rather than capital leases, and thus did not need to be approved by the Minister of Finance as borrowings. Crown corporations report under either Public Sector Accounting Standards (PSAS) or IFRS standards, depending on their operations. footnote 6 Of the 44 Crown corporations subject to the Regulations, 25 report under IFRS and 19 report under PSAS.
The 25 Crown corporationsfootnote 7 subject to Part X of the FAA that report under IFRS will be required to adopt IFRS 16 Leases. Crown corporations reporting under PSAS will continue to classify leases as capital leases or operating leases and will not be affected by the change to IFRS standards.
IFRS 16 Leases will require thousands of previously unrecognized leases to be capitalized and increase the recognized liabilities on the Crown corporations’ balance sheets. Under the existing threshold, a significant number of leases that Crown corporations enter into will now require ministerial approval, even if they are of insignificant value (i.e. they would not have a significant impact on the Government’s financial position, nor the fiscal framework).
Implementing IFRS 16 Leases under the existing threshold in the Regulations would significantly increase the administrative burden and reduce operational efficiency for affected Crown corporations since numerous new leases with insignificant value would trigger the need to obtain the approval of the Minister of Finance.
The objectives of this amendment are to
- ensure that the threshold for seeking the Minister of Finance’s approval on the specific terms and conditions of capital lease transactions continues to allow for oversight of Crown corporations’ significant lease liabilities; and
- reduce the anticipated administrative burden for Crown corporations and the Government by changing the threshold that determines when the Minister of Finance’s approval must be sought.
If the threshold for requiring Crown corporations to seek the Minister of Finance’s approval on the specific terms and conditions of capital lease transactions is maintained at the current level of 1% of the total assets of the Crown corporation and $100,000, the adoption of IFRS 16 Leases would trigger a requirement for the Minister to approve thousands of leases of insignificant value.
Accordingly, subsection 10(b) of the Regulations is amended to increase the threshold from “the lesser of 1 per cent of the total assets of the Crown corporation and $100,000” to “the lesser of 5% of the total assets of the Crown corporation, or $10,000,000.”
The higher threshold would maintain an appropriate level of ministerial oversight over transactions that are financially significant to a given Crown corporation. This is preferable to maintaining the current threshold, as it reduces the administrative burden for Crown corporations. It is also preferable to adopting a universal dollar-value threshold (e.g. $10 million). While such a threshold could provide ministerial oversight of transactions that are significant to the Government, it would not provide adequate oversight of the financial management of small Crown corporations whose total assets are lower than the threshold, for example.
Overall, changing the threshold in the Regulations will reduce the administrative burden associated with having to seek the Minister of Finance’s approval of thousands of insignificant leases. However, the threshold will not eliminate all administrative burden. Four Crown corporations will have to submit a borrowing plan, whereas before IFRS 16 Leases, they did not have to.
The requirement to seek the Minister of Finance’s approval for borrowing transactions is in the FAA. The administrative requirements for completion of a borrowing plan are set in policy by the Department of Finance (Finance Canada). The Regulations would result in a net reduction in administrative burden that derives from legislative and policy (not regulatory) requirements. The “One-for-One” Rule does not apply to this amendment because it does not increase or reduce administrative burden associated with regulatory requirements.
Small business lens
The small business lens does not apply to this amendment, as it will not impact small businesses.
Since October 2016, Finance Canada has held extensive consultations on the upcoming change in accounting requirements for leases and the amended threshold with the Chief Financial Officers (CFOs) of all Crown corporations; their portfolio departments; and the Treasury Board Secretariat (TBS) Crown Corporation Centre of Expertise and Office of the Comptroller General. Finance Canada engaged all parties through written communications on a quarterly basis, organized a formal stakeholder consultation, held a round-table discussion with all parties, and met with individual officials to answer questions as they came up. Two legislative issues and one regulatory issue were raised during the consultation process.
First, the new accounting standard will increase the number of Crown corporation leases that would be considered borrowings under the Regulations, and would therefore likely affect the individual statutory borrowing limits of Crown corporations that have borrowing limits embedded in their enabling acts.
Second, some Crown corporations do not have the authority to borrow. Since capitalized leases are considered borrowings, once IFRS 16 Leases comes in effect, these Crown corporations would be prevented from entering into any capitalized lease agreements, which they need to be able to enter into for their day-to-day operations. These issues were addressed by amendments to the FAA made through Budget Implementation Act, 2018, No. 1, which received royal assent on June 21, 2018. The amendments to the FAA provide that lease transactions do not count towards Crown corporations’ statutory borrowing limits (i.e. total borrowing limits would be calculated net of capital leases), and allow all Crown corporations to have the authority to enter into lease transactions, regardless of whether or not they have borrowing authority.
In October 2016, Finance Canada engaged all Crown corporations CFOs to inform them that starting in January 2019, IFRS 16 will be in effect and to explain the implications it will have on the threshold requirements imposed by the Regulations. Finance Canada sought views on the potential impact of IFRS 16 on Crown corporations. Crown corporations that follow IFRS have expressed concern that once IFRS 16 takes effect, the $100,000 regulatory threshold will be too low (e.g. some Crown corporations would have hundreds or thousands of low value leases that would need to be approved), which would increase Crown corporations’ and the Government’s administrative burden.
Finance Canada subsequently requested a list of Crown corporations’ leases that are likely to be capitalized on their balance sheets starting in 2019. Eight Crown corporations informed Finance Canada that they are exempt from Part X of the FAA and will not have to seek approval from the Minister. Some Crown corporations (e.g. Canadian Commercial Corporation) indicated they do not plan to enter into right-of-use leases footnote 8 in the near future, while others were still in the process of assessing the impact.
Thirteen Crown corporations were able to provide data on their leases (e.g. Canada Post, Canada Mortgage and Housing Corporation, and VIA Rail). Most right-of-use leases would likely be for real estate and office equipment (e.g. photocopiers) and a majority of the transaction values not related to real estate would be less than $1 million.
Based on the data received, Finance Canada, in consultation with internal partners, concluded that the nature and value of the majority of leases that would require the Minister of Finance’s approval due to IFRS 16 would pose minimal financial risk to the Government, and that the effort and time that would be spent by Crown corporations and Finance Canada to seek the Minister of Finance’s approval would outweigh any minor benefits from oversight of these lease transactions.
Given the need for the Minister of Finance to approve significant lease transactions, the recommended solution was to increase the regulatory threshold in order to reduce the administrative burden, while maintaining a proper oversight of leases that have a significant financial impact on a Crown corporation or the Government.
Regulatory and non-regulatory options considered
The existing threshold is set in regulations because this is what the FAA requires. Therefore, the only way to modify the existing threshold is to amend the Regulations.
Determining the appropriate threshold
The FAA requires Crown corporations to seek the Minister of Finance’s approval for any amount of borrowings; there is no established threshold. Since the majority of lease transactions are for the day-to-day operations of Crown corporations and are of significantly low value (less than $1 million), an exception to the rule that all borrowings must be approved by the Minister has been established through the regulatory threshold deeming capital leases to be borrowings.
After extensive consultation, it was determined that lease transactions entered into by Crown corporations over $10 million have sufficient financial and reputational risk to the Government to warrant ministerial approval. From the data provided, three Crown corporations (Export Development Canada, the Canadian Air Transport Security Authority [CATSA] and VIA Rail) indicated real estate leases valued over $10 million.
When evaluating the balance sheets of individual Crown corporations, liabilities over 1% of the Crown corporation’s total assets (i.e. the existing threshold) is considered too low for ministerial approval as these liabilities would not pose significant financial or reputational risk at the entity level. In comparison, a lease transaction valued at 5% of total assets would be considered significant enough at the entity level to warrant ministerial oversight. Therefore, the Regulations are amended to increase the threshold, which will require ministerial approval of capitalized leases equivalent to the lesser of 5% of total assets or $10 million.
The higher threshold would limit the number of lease transactions that require the approval of the Minister of Finance, thereby significantly reducing the administrative burden anticipated by some Crown corporations. Based on the impact analysis below, the approval process should not create significant additional administrative burden for Crown corporations.
Impact analysis on IFRS 16 and the Regulations
Currently, 32 out of 44 Crown corporations prepare borrowing plans when seeking borrowing approvals; eight are exempt from Part X of the FAA and do not require ministerial approval for their borrowings (e.g. Bank of Canada); four do not currently prepare borrowing plans and will be required to do so if they have significant right of use leases.
The sixteen Crown corporations, out of 32, that are currently preparing borrowing plans, are unlikely to seek borrowing approvals for significant leases because they follow PSAS. Finance Canada does not expect that they would be affected by the regulatory change since their accounting model has not changed and they generally enter into operating leases or capital leases falling below the current threshold. Finance Canada does not expect their practices to change, and the significant increase in the threshold makes it even more unlikely that their capital lease transactions would require the Minister’s approval.
Of the 44 Crown corporations, 25 follow IFRS and are subject to Part X of the FAA. They are likely to be affected by IFRS 16 Leases and the change to the Regulations, as they would need to prepare a borrowing plan if they plan to enter into significant leases in the upcoming year (2019), and going forward. The affected leases are likely to be real estate leases. Of these 25 Crowns, 21 already prepare borrowing plans and are familiar with the process and timing of borrowing plan approvals.
Four Crown corporations (CATSA, VIA Rail, Atomic Energy of Canada Limited [AECL], and the Canadian Museum of History) do not currently prepare a borrowing plan but will need to do so if they plan to enter into a significant lease agreement in the coming year and going forward. When seeking the Minister’s approval, Crown corporations must disclose three key pieces of information: a short description of the lease or asset class of the lease, the maximum number of years, and the total estimated liability. Finance Canada encourages Crown corporations to incorporate additional buffer years and liability values into their requests to provide flexibility when negotiating leases. Crown corporations must already obtain this information in order to complete their forecasted financial statements. Therefore, there will be little to no additional burden for Crown corporations in providing the information to Finance Canada in the form of a table. While providing borrowing approval for four additional Crown corporations will be some additional work for Finance Canada, it is not anticipated to be significant.
Finance Canada does not expect most Crown corporations to seek approval for leases on an annual basis because leases requiring approval are likely to be long-term real estate leases (e.g. 20 to 30 years).
This amendment would not result in additional costs for external stakeholders. The additional work involved for Crown corporations and Finance Canada in seeking the Minister of Finance’s approval of borrowing plans is not expected to have an impact on existing resource allocations. Any minor resource implications needed for borrowing plans would have to be absorbed through existing budgets.
Implementation, enforcement and service standards
The amendments come into force on January 1, 2019, and new requirements will be reflected in its Guidance for Crown Corporations on Preparing Corporate Plans and Budgets on the TBS website. Crown corporations will be required to provide a brief description of each lease, the maximum number of years of each lease and the maximum value of each lease. Crown corporations will seek the Minister’s approval for upcoming leases by preparing an annual borrowing plan.
Four Crown corporations (CATSA, VIA Rail, AECL and the Canadian Museum of History) do not currently prepare a borrowing plan but will be required to do so if they plan to enter into a lease agreement above the regulatory threshold in the coming year. It is unlikely that these Crown corporations will enter into significant leases on an annual basis. However, they would need to prepare a borrowing plan on an ad hoc basis for any significant leases they enter (e.g. long-term real estate leases). The implementation plan for these four Crown corporations is as follows:
- (1) On an annual basis, Finance Canada will inquire if affected Crown corporations plan to enter into significant leases in the coming year.
- (2) Finance Canada will work directly with affected Crown corporations to guide them through the borrowing plan and approval process.
- (3) The Minister of Finance has discretion to establish the terms of the borrowing approval, on a case-by-case basis, based on a given Crown corporation’s situation. Finance Canada will determine the appropriate terms of approval (e.g. options could include annual, biannual and standing approvals).
- (4) Finance Canada will keep track of the expiry date of these borrowing approvals, as it does with all other Crown corporation borrowing approvals, and re-engage with the Crown corporations well in advance of their borrowing approval’s expiry.
Funds Management Division
Financial Sector Policy Branch
Department of Finance