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HMRC internal manual

Business Leasing Manual

HM Revenue & Customs
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Lease accounting: leasebacks and sub-leases: sub-leases

The three parties to a chain of leases may be termed

  • the original or head lessor
  • the intermediate party, intermediate lessor, the sub-lessor, head lessee
  • the ultimate lessee, sub- lessee or end-user.

In effect, the intermediate party is both a lessee in the original (or head) lease and a lessor as regards the sub-lease.

Original lessor – UK GAAP and IFRS

In normal circumstances, where the sub-lease is entered into independently of the head lease, the accounting for the original lease by the original lessor should not be affected by the fact that the intermediate party enters into a sub-lease, unless the original lease is replaced by a new agreement.

Intermediate party – UK GAAP

However, the accounting by the intermediate party is more complex and will depend on the structure of the arrangements with both the original lessor and the ultimate lessee.

Where the intermediate lessor is in substance only acting as a broker or agent between the original lessor and the end-user the intermediary should not account for the leased asset as an asset, nor account for the lease obligations as a liability. Instead the net income (which will represent any difference between the head- and sub-lease rentals) should be accounted for as income.

This would be the case where, for example, the rentals under the head finance lease are payable only if the intermediate lessor receives rentals under the sub-lease (that is, the head lessor has no recourse to the intermediate party in the event of default by the sub-lessee).

Conversely, where the intermediate party enters into a lease with the original lessor, the terms of which require payments to be made to the lessor regardless of whether payments are received from the ultimate lessee then the leases should be accounted for separately. This situation might arise where the asset is sub-leased by the intermediate party to the ultimate lessee, but the lease agreement between the original lessor and the intermediate party remains in effect. If the original lease is a finance lease, the intermediate party should record the lease obligation that arises thereunder. If the sub-lease is also a finance lease, the intermediate party should account for the lease receivables due from the ultimate lessee. The asset will therefore not be recorded by the intermediate party. If the sub-lease is an operating lease, the leased asset remains as a fixed asset. The principal differences which arise if the sub-lease is a finance lease as opposed to an operating lease are that the intermediate party (a) treats the asset as a receivable instead of a fixed asset and (b) recognises income according to finance lease principles.

Intermediate party – IFRS

Conceptually the accounting under IFRS is similar to UK GAAP.

Where the head lease is an operating lease the sub-lease must always be an operating lease, and rentals received and paid are accounted for separately, unless the party is genuinely acting as an agent in which case only the margin the agent makes would be recorded.

Where the head lease is a finance lease, the sub-lease could be classified as either an operating or finance lease. The derecognition rules in IAS 39 as they relate to assets and liabilities must be applied. Where the sub-lease is an operating lease the asset and finance lease liability remain on the balance sheet. Where the sub-lease is a finance lease, the asset is derecognised and a finance lease receivable recognised in its place and income recorded in accordance with IAS 17. The finance lease creditor will only be derecognised if the derecognition criteria in IAS 39 are met (the liability is discharged, cancelled or expires).

If in doubt as to whether or not the derecognition criteria are met, you should contact your local advisory accountant.

Ultimate lessee – UK GAAP and IFRS

The ultimate lessee should classify the sub-lease according to the accounting principles explained from BLM10010 onwards and account for it accordingly.