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HMRC internal manual

Business Leasing Manual

Defining long funding leases: amendments, transfers and assignments: transfers by lessor of long funding operating lease - example

A Ltd buys a train for £10m. On 1 June 2007, it leases the train to X Ltd on a 15-year long funding operating lease.

After 5 years, on 1 June 2012, when the lease still has 10 years to run, A Ltd sells the asset subject to the lease to B Ltd and the lease is novated to B Ltd so that B Ltd becomes the lessor. At that point the train is worth £8m, which is what B Ltd pays A Ltd.

The only change in the lease is the change in lessor and so the term of B Ltd’s lease to X Ltd is 10 years, the unexpired portion of A Ltd’s lease to X Ltd. Also, there is no change in the rents payable by X Ltd (but see BLM41030).

A Ltd’s lease with X Ltd is treated as terminating and B Ltd is treated as if it had entered into a lease with X Ltd immediately after the transfer, as if that lease had started on the transfer date and as if the term of the new lease started on the transfer date. In this example, because of the novation, this is likely to be the correct interpretation of the law in any event.

B Ltd will be taxed on the basis that the lease is a long funding lease. This ensures that if X Ltd was claiming capital allowances its right to do so is not disturbed.

A Ltd’s income over the term of the lease is determined on the basis that the train had a value of £8m at the end of the term - thus A Ltd is taxed on the profit made over the period to 1 June 2012. B Ltd will be taxed on the profit it makes under its lease assuming the asset cost £8m.

See BLM42040 for guidance on taxation of long funding operating leases.