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HMRC internal manual

Business Leasing Manual

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Defining long funding leases: election: following the accounts: operating leases - depreciation policy

GAAP does not require entities to use a straight-line depreciation policy, though that would normally be the case. However, there are variants on straight-line depreciation that do not mirror the rules for taxing long funding operating leases.

Example 1

An asset has an expected economic life of six years and is acquired by a lessor for £6000. It is leased under a four year operating lease at an annual rental of £1500. The lessor estimates that its value at the end of the lease will be £2000. The difference, £4000, will be an allowable deduction under CTA10/Ss363-365 (or ITTOIA05/S148D), at a rate of £1000 per year.

The lessor depreciates the asset on a straight-line basis over the life of the asset with the result that the annual depreciation is £1000. The depreciation is calculated on a time basis and the depreciation shown in the accounts varies according to when the asset is acquired.

That is, where the asset is acquired on the first day of the accounting period the depreciation is £1000; where the asset is acquired half way through the year, depreciation is £500. This is the same as the statutory methodology.

Example 2

As Example 1, except that lessor’s depreciation policy is to deduct a full year’s depreciation in the accounts in the year of acquisition, whenever it is acquired. So even if the asset is acquired at the end of the period of account, the lessor accounts for a full year’s depreciation.

Example 3

As Example 1, but in the first year the lessor writes off one third of the value of the asset on the grounds that that reflects the actual loss in value of the asset over the first year of its life, and then moves on to straight line depreciation. This approach results in a deduction for depreciation of £2000 in the first year, rather than the £1000 deduction of the statutory method.

In these examples, only the depreciation policy in Example 1 would allow a lessor to follow the figures in the accounts.

In a variant on Example 1, a lessor may choose to depreciate each asset on the assumption it is acquired half way through the year. If the pattern of purchases is spread evenly over the whole year this may give essentially the same result as in Example 1. It would be for the lessor to demonstrate this is the case.

Where a lessor incurs additional capital expenditure on leased assets the same depreciation policy should be followed to mirror the statutory rule in CTA10/Ss366-368 (or ITTOIA05/S148E) BLM41020.