Taxation of leases that are not long funding leases: finance lessees: termination adjustments: termination rental
On premature termination of a finance lease, the lessee is may be required to make a payment equal to the discounted value of the rentals that should have been paid had the lease continued. On its own this would be harsh, but the lessee is also entitled to require the lessor to sell the asset and pay almost all (typically 99% or more) of the proceeds to the lessee. Therefore, as long as the asset has a relatively high value it will, in commercial terms, offset the terminal rental due. Where the asset has a value higher than the terminal rental the lessee will receive rebate higher than the terminal rental. Where the asset has a value lower than the terminal rental the lessee’s terminal rental will exceed the terminal rebate. In a typical termination this will leave the lessor with a financier’s return on his investment (but see BLM15540 for other adjustments that may be made).
Whether the termination rental is actually netted off against the rental rebate or whether the rental is paid and the rebate received (perhaps at a later date) is be a matter of commercial agreement between the lessor and lessee and is likely to be set out in the lease documentation, but may be in a separate document.
Some lease agreements may only require the lessee to pay a terminal rental equal to the present value of the remaining lease rentals less 99% (or thereabouts) of the value of the leased asset at termination. Where that is the case there is no ‘netting off’ of contractually due payments, rather the contract itself provides that only the net amount is due. If the value of the leased asset exceeds to present value of the rentals, the lessee will just be due a rebate of rentals.
See BLM32320 for guidance on when a termination payment by a lessee may be capital.