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HMRC internal manual

Business Leasing Manual

Defining long funding leases: introduction: background

Finance leases (and some operating leases) are commercially very similar to loans and yet prior to FA 2006 the tax treatments were very different. This meant that in some cases commercial decisions - whether to borrow or lease - were affected by the tax treatment of the transaction. That is, some commercial decisions were distorted as a result of the tax regime.

The rules introduced by FA 2006 reduce this distortion by taxing longer leases that function as financing transactions (‘long funding leases’) by reference to their commercial substance rather than their legal form. In short, and in very broad terms, the rules introduced by FA 2006 tax such leases in a similar way to a loan, though they are not loans and so are not taxed as loans under the loan relationship rules.

In broad terms, the long funding lease rules apply to leases entered into on or after 1 April 2006. There are exceptions to this rule with the result that the long funding lease rules

  • do not apply to some leases entered into on or after 1 April 2006
  • do apply to some leases entered into before 1 April 2006.

Full details of the commencement and transitional rules are at BLM23000 onwards.

Lessors may elect for leases to be treated as long funding leases, see BLM24000.

At the same time as the long funding lease rules were introduced the rules which restricted the capital allowances available to lessors who leased plant or machinery to overseas lessees were phased out, see CA24005. Thus where lessors are entitled to capital allowances because the lease is not a long funding lease, they will not lose that entitlement where the lessee is overseas.

The changes introduced by FA 2006 represent a major change in tax treatment but they only reduce, rather than eliminate, distortion. Therefore their effect on the behaviour of lessors and lessees is being monitored by CTIS (CT&BIT) as part of the normal processes following the introduction of new legislation. See, in particular, BLM31010.