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HMRC internal manual

Business Leasing Manual

Defining long funding leases: the three tests: the finance lease test: CAA01/S70N

The finance lease test is met if under GAAP (BLM20215)

  • the lease is or should be accounted for as a finance lease or loan in the accounts of the person to whom the decision applies (lessor or lessee, as appropriate), or
  • in the case of a lessor, the lease is or should be accounted for as a finance lease or loan in the accounts of anyone connected with the lessor, including in the consolidated accounts, see BLM20220.

Note that a lease meets the finance lease test if it is, or under GAAP should be, accounted for as a finance lease or loan by a connected party, even if it is not accounted for as a finance lease or loan by the lessor.

At present, it is probable that the only time a plant or machinery lease could be argued to be accounted for as a loan is

  • by the lessee, and possibly by the lessor, in a lease and finance leaseback or sale and finance leaseback (where the accounting applies throughout the life of the arrangement) see BLM16010 and BLM16015 
  • in the case of both the lessor and the lessee where payments are made between inception of a lease and its commencement. (The arrangement will be accounted for as a lease after commencement, even if it is not before commencement).

Even in some of these cases, particularly in the case of a sale and finance leaseback, it is probable that the correct accounting treatment is ‘as a lease’. In any event, it is probable that all other plant or machinery leases are accounted for as a lease (BLM20130). However, accounting standards - and the transactions to which they apply - are continually developing and often becoming more complex. As a consequence it is not possible to give comprehensive guidance, particularly where it is appropriate to apply FRS 5 Reporting the Substance of Transactions, or how to determine the substance of an arrangements under Section 20.3A of FRS102, or when applying the IFRS guidance. Always bear in mind that the legislation applies on the basis of what is GAAP at a particular time.