Perpetual lease of land

Most write-ups of this fact pattern go straight to the question everyone finds interesting — is the lease term infinite? — and answer it by asking whether renewal is "reasonably certain." That sequence is wrong, and getting it wrong changes the answer.

IFRS 16 does not let you begin with reasonable certainty. It makes you first establish how long the contract is enforceable, and only then ask what the lessee is reasonably certain to do inside that window. For an ordinary five-year office lease the two steps collapse into one and nobody notices. For a lease that renews forever, the first step is the whole analysis.

This post walks the fact pattern in the order the standard actually requires. The short version: it is a lease, the lease term is almost certainly very long but not infinite, the premium sits in the right-of-use asset and not the liability, the depreciation question is genuinely unsettled, and the below-market rent may or may not be a government grant depending on how the scheme is structured.

Step 1: Is it a lease at all?

The threshold test is IFRS 16.9: a contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. IFRS 16.B9 unpacks "control of use" into two rights held throughout the period of use — the right to obtain substantially all of the economic benefits from use of the identified asset, and the right to direct its use.

Before applying that test, clear the scope exclusions in IFRS 16.3. Two are live for government land arrangements. If the land is made available as part of an arrangement in which the operator provides a public service using infrastructure controlled by the grantor, IFRIC 12 may apply instead (IFRS 16.3(c)). And if the land comes bundled with mineral or hydrocarbon rights, IFRS 16.3(a) removes that element. Neither applies to a straightforward long-leasehold plot, but both are worth documenting rather than assuming away.

Assuming the arrangement clears scope, the objection you will actually meet in an audit file is: a right that never ends is not a right "for a period of time," so this is a purchase of land, not a lease.

The IASB considered exactly this and rejected it. IFRS 16.BC78 records that some stakeholders suggested long-term leases of land be excluded from the scope of IFRS 16 because such leases are sometimes regarded as economically similar to buying the land. The Board declined, reasoning that there is no conceptual basis for differentiating long-term leases of land from other leases, and that if the contract does not transfer control of the land but gives the lessee the right to control its use throughout the lease term, it is a lease. BC78 goes on to acknowledge the economic point directly: for a 99-year lease the present value of the lease payments is likely to represent substantially all of the fair value of the land, so the lessee's accounting will end up resembling the accounting for a purchase anyway.

That is the strongest support available for treating this as a lease, and it is also an admission that the distinction carries less weight than the debate implies.

Two points on the facts as usually described:

• Legal title not transferring is relevant but not decisive. IFRS 16 has no title test for lessees; the lessee model applies to every lease regardless of whether ownership passes. Title matters here only as evidence that control of the asset was never conveyed — it is not itself the test.

• The lessee model has no "bargain purchase option" concept. That language belongs to lessor classification. For a lessee, a purchase option matters in two specific places: IFRS 16.27(d) (its exercise price enters the liability if exercise is reasonably certain) and IFRS 16.32 (it changes the depreciation period). It is not a scope switch.

Where this genuinely divides: in jurisdictions where the right is perpetual by construction rather than by successive renewals — Poland's perpetual usufruct being the clearest case — practice is not uniform, and the "period of time" objection has real force. If your reporting jurisdiction has an established local answer, say so and follow it. If it does not, disclose the judgement rather than presenting the conclusion as obvious.

Step 2: The enforceable period

IFRS 16.B34 is the gate:

In determining the lease term and assessing the length of the non-cancellable period of a lease, an entity shall apply the definition of a contract and determine the period for which the contract is enforceable. A lease is no longer enforceable when the lessee and the lessor each has the right to terminate the lease without permission from the other party with no more than an insignificant penalty.

In November 2019 the IFRS Interpretations Committee published an agenda decision, Lease Term and Useful Life of Leasehold Improvements (IFRS 16 and IAS 16), addressing cancellable and renewable leases. The renewable lease in that submission was one specifying an initial period that then renews indefinitely unless terminated by either party. That is structurally your fact pattern.

Three things from that agenda decision do real work here:

1. "Penalty" is an economic concept, not a contractual one. The Committee observed that in applying B34 an entity considers the broader economics of the contract, not only contractual termination payments. If either party has an economic incentive not to terminate such that it would incur a more-than-insignificant penalty on termination, the contract is enforceable beyond the date on which it can be terminated. An entity that has paid a large upfront premium and built on the site has a very substantial economic disincentive to walk away — so the enforceable period extends well past any nominal renewal date.

2. Enforceability ends only when both parties can walk. The Committee was explicit: a lease is no longer enforceable only when both parties have the right to terminate without permission and with no more than an insignificant penalty. If only one party has that right, the contract is enforceable beyond that date. This cuts against the usual instinct. The government's reversionary right to reclaim the land does not shorten the enforceable period on its own — the lessee also has to be able to exit cheaply, and having paid a premium, it cannot.

3. Only then do you reach reasonable certainty. If an entity concludes the contract is enforceable beyond the initial period of a renewable lease, it then applies IFRS 16.19 and B37–B40 to assess whether the lessee is reasonably certain not to exercise the option to terminate.

The agenda decision also quotes IFRS 16.BC156, which sets out the Board's view that the lease term should reflect an entity's reasonable expectation of the period during which the underlying asset will be used, because that approach provides the most useful information.

BC156 is the sentence that resolves the perpetuity question. The lease term is anchored to a reasonable expectation of use, not to the outer limit of legal entitlement. No entity has a reasonable expectation of using a site for an infinite period. What it has is a reasonable expectation of use over a long, estimable horizon. The lease term is therefore long and finite — determined by expected utility, bounded by enforceability — and the "infinite term" framing dissolves without needing a practical expedient to rescue it.

Step 3: Lease term within that ceiling

With the enforceable period established, IFRS 16.18 applies in the normal way: the lease term is the non-cancellable period, plus periods covered by an extension option the lessee is reasonably certain to exercise, plus periods covered by a termination option the lessee is reasonably certain not to exercise.

IFRS 16.19 requires consideration of all relevant facts and circumstances creating an economic incentive, as described in B37–B40. B37 lists factors including the contractual terms for optional periods compared with market rates, and expected changes in facts and circumstances between commencement and the exercise date.

For this fact pattern the incentive analysis is one-sided and easy: renewal is at nominal cost, the site carries a sunk premium, and any improvements built on it are unrecoverable. Reasonable certainty is not the hard part. The hard part is the horizon, and that is a matter of the entity's reasonable expectation of use per BC156, not of how far the legal right theoretically stretches.

In practice this lands on a long finite term — often the stated contractual cycle (99 years is common) or the expected economic horizon of the entity's use of the site, whichever the facts support. State which, and state why.

Step 4: Initial measurement

IFRS 16.22 requires recognition of a right-of-use asset and a lease liability at commencement, with the ROU asset measured at cost (IFRS 16.23).

Right-of-use asset — IFRS 16.24. Cost comprises: the initial measurement of the lease liability; any lease payments made at or before the commencement date, less any lease incentives received; initial direct costs; and an estimate of dismantling, removal and restoration costs.

The upfront premium falls squarely within 24(b). It enters the ROU asset at the amount actually paid, undiscounted, because it has already been settled.

Lease liability — IFRS 16.26. The liability is the present value of the lease payments not paid at that date, discounted at the interest rate implicit in the lease if readily determinable, otherwise the lessee's incremental borrowing rate. IFRS 16.27 lists what goes in.

The premium is not in the liability. It is not a future payment.

Worked example

An entity pays a government an upfront premium of $5,000,000 for a land lease that renews indefinitely, with ground rent of $10,000 per year payable in arrears. Its incremental borrowing rate is 7%. (Where the rent is stated monthly, convert to a consistent periodic rate — it does not change the analysis.)

At 7%, the difference between assuming a perpetuity and using a 99-year horizon is $176.

But that convergence is a function of the discount rate, not a general truth. The perpetuity PV is rent ÷ r, which is hyperbolically sensitive to r:

At a 7% IBR the horizon assumption is immaterial. At 2% it is not. Anyone reproducing the "it makes no difference" argument in a low-rate environment, or for an entity with a strong credit profile, should recompute rather than assume.

Note also what happens to the unwind. At 7% on a liability of $142,681, first-year interest is $9,988 against rent of $10,000 — the liability amortises by $12 in year one. Over a long horizon the ground rent is almost entirely interest, and the liability sits essentially static on the balance sheet. That is arithmetically correct and worth explaining in the notes, because it looks wrong to a reader who expects a lease liability to unwind.

Step 5: Depreciation

IFRS 16.31 requires a lessee to apply the depreciation requirements in IAS 16 to the ROU asset, subject to IFRS 16.32. IFRS 16.32 provides that unless the lease transfers ownership by the end of the lease term, or the ROU asset's cost reflects that a purchase option will be exercised, the lessee depreciates from commencement to the earlier of the end of the useful life of the right-of-use asset or the end of the lease term.

First, a carve-out that is frequently missed. IFRS 16.34 requires that if a lessee applies the IAS 40 fair value model to its investment property, it must also apply that fair value model to right-of-use assets meeting the IAS 40 definition of investment property. If the leased land is held to earn rentals or for capital appreciation, the depreciation debate below never arises — the ROU asset is carried at fair value through profit or loss. Check this before anything else.

For everyone else, two defensible positions:

Position A — depreciate over the lease term. The ROU asset is a right to use land for a period; it is not land. IAS 16.58's reasoning — that land has an unlimited useful life and therefore is not depreciated — attaches to the underlying asset, not to a wasting contractual right over it. On a 99-year term, straight-line depreciation of $5,142,681 gives roughly $51,900 a year. This is the mainstream position and the one an auditor will default to.

Position B — do not depreciate. If the lease term has been concluded to be indefinite, both limbs of the IFRS 16.32 test are unbounded and there is no period to depreciate over.

Position B depends entirely on having concluded an indefinite lease term — which, as Step 2 sets out, is difficult to sustain once B34 and BC156 are applied properly. If your enforceable-period analysis produced a long finite term, Position B is not available to you. The two conclusions have to be consistent.

There is also a consequence of Position B worth stating plainly, because it is uncomfortable. A non-depreciated ROU asset is tested for impairment under IAS 36 (IFRS 16.33), and IAS 36.9 requires an assessment for indicators at each reporting date, with a formal estimate of recoverable amount only where an indicator exists. IAS 36.10 imposes a mandatory annual test only on goodwill and on intangible assets with indefinite useful lives or not yet available for use. So a multi-million ROU asset held indefinitely and never depreciated escapes the annual test that an indefinite-life intangible of the same size would attract. Same economics, weaker rigour. That gap is not addressed anywhere in the standards.

Step 6: Ground rent revisions

This is where the fact pattern most often gets mishandled, because the intuition ("the rent is variable, so expense it") points the wrong way.

The distinction in IFRS 16 is not fixed versus variable. It is variable-by-reference-to-an-index-or-rate versus variable on some other basis.

• IFRS 16.27(b) requires variable lease payments that depend on an index or a rate to be included in the liability, initially measured using the index or rate at the commencement date.

• IFRS 16.28 gives the examples: payments linked to a consumer price index, payments linked to a benchmark interest rate, or payments that vary to reflect changes in market rental rates.

• IFRS 16.42(b) requires remeasurement where there is a change in future lease payments resulting from a change in an index or rate, "including for example a change to reflect changes in market rental rates following a market rent review," but only when the change in cash flows actually takes effect.

• IFRS 16.43 requires an unchanged discount rate for a 42 remeasurement, unless the change results from a change in floating interest rates.

• IFRS 16.38(b) sends variable payments not included in the liability to profit or loss, in the period the triggering event occurs.

A ground rent subject to periodic revision to market is IFRS 16.28's third example almost verbatim. It belongs in the liability at the commencement-date rate, and is remeasured under 42(b) when each revision bites, at an unchanged discount rate. It is not expensed as incurred.

This is also not a modification. A modification is a change in scope or consideration that was not part of the original terms and conditions. A rent review operating under the existing contract is not one. IFRS 16.44–46 are engaged only where the parties renegotiate something the contract did not already provide for — for instance, if the lessee acquires additional land (test IFRS 16.44 for separate-lease treatment) or surrenders part of the site (IFRS 16.46(a)).

Step 7: Reassessment

IFRS 16.20 requires a lessee to reassess whether it is reasonably certain to exercise an extension option, or not to exercise a termination option, upon a significant event or significant change in circumstances that (a) is within the control of the lessee and (b) affects that assessment. IFRS 16.B41 gives examples: unanticipated significant leasehold improvements expected to have significant economic benefit when the option becomes exercisable; significant modification or customisation of the underlying asset; entering into a sublease extending beyond the previously determined term.

The control condition is a real constraint, and it eliminates the example that everyone reaches for first. A change in government land policy is not within the lessee's control and is therefore not an IFRS 16.20 trigger. That does not make it irrelevant — it is very likely an impairment indicator under IAS 36.9, and it may bear on the enforceable period at the next reassessment point — but it does not force a lease-term reassessment under 20.

Genuine 20/B41 triggers here look like: the entity develops the site far beyond what was contemplated at commencement; it subleases beyond the assumed horizon; it commits to relocate.

IFRS 16.21 is separate and operates on a different logic. It requires the lease term to be revised where there is a change in the non-cancellable period — including where the lessee exercises or fails to exercise an option previously included or excluded, or an event contractually obliges or prohibits exercise. No control condition attaches to 21.

Where either applies, IFRS 16.40(a) requires the liability to be remeasured using a revised discount rate — note the contrast with the unchanged rate under 42/43 — with the adjustment taken against the ROU asset under IFRS 16.39.

Step 8: The below-market rent: is there a government grant?

The contractual ground rent is deliberately far below what a commercial lessor would charge. Is there an embedded grant?

The IFRS 16 mechanics give no automatic answer. IFRS 16.26–27 measure the liability using the contractual payments. There is no imputation of market rent for an ordinary lease. The one place IFRS 16 does require off-market terms to be adjusted is IFRS 16.101, which applies only to sale and leaseback: where the consideration for the sale is not at fair value, or the lease payments are not at market rates, below-market terms are accounted for as a prepayment of lease payments and above-market terms as additional financing from the buyer-lessor. IFRS 16.102 sets the measurement basis. This is a sale-and-leaseback rule and does not travel to a standalone lease.

IAS 20 is where the argument actually lives, and it is stronger than "no rule, therefore no grant."

• IAS 20.3 defines government grants as assistance in the form of transfers of resources in return for past or future compliance with conditions relating to the entity's operating activities, excluding forms of assistance that cannot reasonably have a value placed on them.

• IAS 20.10A treats the benefit of a government loan at a below-market rate of interest as a government grant, measured as the difference between the IFRS 9 initial carrying value and the proceeds received.

• IAS 20.23 addresses grants taking the form of a transfer of a non-monetary asset, such as land, for the use of the entity: it is usual to assess the fair value of the asset and account for both grant and asset at that fair value, though an alternative sometimes followed is to record both at a nominal amount.

• IAS 20.7 blocks recognition until there is reasonable assurance that the entity will comply with attached conditions and that the grant will be received.

• IAS 20.24 permits presentation either as deferred income or as a deduction in arriving at the asset's carrying amount, with IAS 20.12 requiring recognition in profit or loss on a systematic basis over the periods in which the related costs are recognised.

So the counter-argument is not weak. IAS 20.10A shows the Board is willing to impute a grant from a below-market financial term, and IAS 20.23 contemplates land specifically. If those two are read together, an entity receiving perpetual land use for a nominal rent looks like a candidate.

What defeats it, where it is defeated, is IAS 20.3 and IAS 20.7. A grant requires identifiable conditions relating to operating activities and a value that can reasonably be placed on the benefit. Where the government's land pricing is simply how that jurisdiction disposes of land — with no separable scheme, no conditions tied to the entity's operations, and no identifiable grant element — IAS 20.3 is not satisfied and there is nothing to recognise. Where the arrangement is a scheme (an industrial development incentive, an enterprise-zone allocation, a job-creation condition), IAS 20 engages and the benefit should be measured and recognised.

The test is therefore not "is the rent below market?" but "is there an identifiable grant, with conditions, capable of reliable measurement?" For a plain long-leasehold disposal, usually no. For a targeted incentive scheme, usually yes.

Public-sector guidance goes further — several jurisdictional adaptations require fair-valuing the right-of-use asset and grossing up a grant for leases at nil or nominal consideration. Those are public-sector adaptations of IFRS 16, not IFRS 16 itself, and they do not bind a commercial entity applying IFRS Accounting Standards. They are also aimed at arrangements where the consideration as a whole is nil or nominal. A $5,000,000 premium is not nominal consideration. It is substantial consideration that happens to be front-loaded, and that distinction should not be blurred.

Disclosure

Get the sources right, because IFRS 16 does not require what it is often said to require.

IFRS 16.51 is the disclosure objective — to give users a basis for assessing the effect of leases on financial position, performance and cash flows. It is not itself a requirement to disclose judgements.

The judgement requirement is IAS 1.122: disclose the judgements, apart from those involving estimations, that management has made in applying accounting policies and that have the most significant effect on the amounts recognised. IAS 1.125 covers assumptions about the future and other major sources of estimation uncertainty with a significant risk of material adjustment within the next financial year. For this fact pattern, both bite — the enforceable period and lease term determination under 122, the discount rate and horizon under 125. (IAS 1 is superseded by IFRS 18 for annual periods beginning on or after 1 January 2027; check the corresponding requirement when that applies.)

IFRS 16.53 requires specified amounts, in tabular format per IFRS 16.54 — including depreciation charge by class of underlying asset (53(a)), interest expense (53(b)), total cash outflow for leases (53(g)), additions to ROU assets (53(h)), and the closing carrying amount by class (53(j)). Note that this is not a full reconciliation of ROU asset movements; IFRS 16 does not require one.

IFRS 16.58 requires a maturity analysis of lease liabilities applying IFRS 7.39 and B11, presented separately from other financial liabilities. For a lease of this length, the "later than five years" bucket will contain essentially the entire undiscounted cash flow, which is uninformative on its own — consider further banding.

IFRS 16.59, read with B48, requires additional qualitative and quantitative information where needed to meet the 51 objective, including exposure to variable lease payments (B49) and extension and termination options (B50). B50 specifically contemplates disclosing the reasons for using such options, their prevalence, and the relative magnitude of optional payments.

IFRS 16.47 governs presentation: ROU assets either presented separately or included in the line item in which the underlying asset would sit if owned, with disclosure of which line.

At minimum, for a material arrangement of this kind, disclose: the enforceable-period conclusion and the reasoning behind it; the lease term adopted; the discount rate and its sensitivity; the depreciation policy and the basis for it; and the government grant conclusion.

What remains unaddressed

Three things the standards do not resolve, which is why this fact pattern keeps generating divergence:

1. IFRS 16 contains no concept of an indefinite lease term. B34 and BC156 push you towards a long finite horizon, but nothing tells you how to set it. Two entities with identical land, identical rights and identical intentions can land on 50 years and 150 years and both comply.

2. A non-depreciated right-of-use asset has no mandatory impairment test. IAS 36.10 reserves the annual test for goodwill and indefinite-life intangibles. Whether that omission is deliberate or simply unanticipated, it is a real gap.

3. The line between a below-market price and a government grant is drawn by IAS 20.3's "identifiable conditions" test, which is judgemental to the point of being unfalsifiable in jurisdictions where the state is the only possible counterparty and there is no market price to compare against.

None of these has a right answer available today. Reach a position, evidence it against B34, BC156 and IAS 20.3 specifically, and disclose it. That is the whole of what the standards ask.

Illustrative fact pattern. Not professional advice. The positions above are interpretations, not answers — your reading of the same standards may differ substantially and still be entirely defensible.