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HMRC internal manual

Business Leasing Manual

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HM Revenue & Customs
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Taxation of leases that are not long funding leases: finance lessees: general issues: why has leasing transaction been undertaken?

Having begun to examine the transaction and having obtained basic documentation, one question that should always be considered is why the transaction has been carried out in the particular way that it has - in particular why lease? Examining the lease agreement may help to answer this question, in particular any payment schedule it includes.

Finance lease agreements often include a schedule setting out all the various payments. It will highlight features like the timing and amount of tax repayments. Details of how tax repayments have been factored into the lease calculations can be particularly significant. Not only do they assist in determining how the lease functions, but they may also enable you to determine if the arrangements are likely to be viewed as at all offensive. It is, however, important to remember that even a standard lease may be part of a scheme designed to avoid tax.

It may help to give an example of a standard lease being used as part of arrangements to avoid tax.

A, B and C are in partnership. C is a tax-paying major bank. They have 0.5%, 0.5% and 99% interests in the partnership respectively and each puts in a proportionate amount of capital so that the partnership has £100m capital. The partnership buys two ships for £50m each and leases them out under a standard lease. There are put options that allow C to require A and B to buy its interest in the partnership for £83m after 6 years.

C receives 99% of the tax losses over the first 6 years of the lease - which might be £60m, generating tax relief worth £18m. The first 6 years’ rentals also repay about 5% of the capital. So at that point C has recovered £5m of its original £99m investment and benefit from tax relief worth £18m, leaving, in effect, £81m invested. Exercising the put option recovers the £81m and gives C a £2m profit over and above any profit arising on the finance charge element of the lease rentals. The £81m is likely to be a capital receipt within the scope of chargeable gains, but as the cost (here £99m) exceeds the proceeds no tax is due.

A and B have increased their investment in the partnership to £84m - which represents the cost of the ships to them. The ‘discount’ of £16m has been paid for by the UK Exchequer. A & B will take steps to ensure that the rental stream is not taxed. If it were taxed, the £18m tax benefits would be recovered.

In this type of arrangement the lease is essentially a standard finance lease (though it could probably equally well be an operating lease) and it is highly unlikely that it will be possible to challenge the lease itself. Rather, it is the surrounding arrangements that lead to avoidance. If you discover that a lease is part of arrangements designed to avoid tax then you should advise CTISA (CT&BIT)

These schemes have been countered by Part 9, Chapters 3-6 CTA 2010, (see BLM81000) but at least some elements of the leasing industry will undoubtedly continue to attempt to convert the deferral of tax over the term of the lease into a permanent loss of tax, particularly on big ticket leases (assets with a value of over £20m).

Indeed, this practice has become so standard in the industry that CTISA (CT&BIT) have even seen a complaint from one major shipping company (which was using an avoidance scheme similar to the one described above) about the fact that Part 9, Chapters 3-6 CTA 2010 has increased the cost of its ships.