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HMRC internal manual

Business Leasing Manual

Introduction: Leasing: What is an operating lease?

SSAP 21 (UK GAAP) and IAS 17 (IFRS and FRS101) define an operating lease as a lease other than a finance lease.

FRS102 says that a lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership (Section 20 paragraph 4). The FRS102 glossary does say “A lease that is not a finance lease is an operating lease”.

In contrast to a finance lease, an operating lease does not transfer substantially all of the risks and rewards of ownership to the lessee. That is, an operating lease is a lease where the lease terms do not guarantee that the lessor will get back all, or substantially all, of the cost of the asset plus a commercial rate of interest. In many cases the asset may be leased several times throughout the course of its life, though this is not always the case, see BLM00060.

This means that operating leasing leaves the lessor with a residual value risk. That is, at the end of the term of the lease the lessor will be relying on the value of the leased asset to ensure they make an overall profit.

In some cases operating lease rentals can be thought of as reflecting the market rate for hiring the asset concerned. However, this is not always the case and has nothing to do with the definition of an operating lease.