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HMRC internal manual

Business Leasing Manual

Introduction: Commercial substance and structure: Finance leases: primary and secondary periods

A finance lease is usually split into ‘primary’ and ‘secondary’ periods. The ‘loan’ (with the ‘interest’) is repaid during the primary period. Once that is over the lessee usually has the option to continue to hire the asset for a nominal rent during the secondary period, either indefinitely or for at least the remaining useful life of the asset.

The structure of the lease is crucial to the nature of a finance lease

  • the primary lease period protects the lessor: it ensures that the loan implied in the lease is repaid just as it would be under an actual loan;
  • the secondary lease period protects the lessee: it recognises that the lessee has acquired economic ownership of the asset and that, without legal title to the asset, the lease must protect the lessee’s right to carry on using the asset.

Rentals payable in the secondary period are usually nominal, reflecting the fact that the lessee has repaid what amounts to the loan. The secondary period rentals are often essentially just sufficient to cover the lessor’s administration costs.

It should be noted that leases are often structured in this way because the parties wish to avoid any provision under which the lessee might become the owner of plant or machinery (and so the lessee can’t simply acquire the asset at the end of the primary period). If they are not, CAA2001/S67 may apply and treat the lessee (not the lessor) as the owner for capital allowances purposes. The effect of section 67 is discussed in detail at BLM00325 onwards.

Note that section 67 only applies to plant or machinery; there is no equivalent rule for other capital allowances codes.