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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not long funding leases: finance lessees: termination adjustments: termination adjustments - whether capital

It does not follow from the guidance at BLM32315 that all terminal payments or receipts under finance leases will necessarily always be revenue in nature.

Occasionally, payments may be made which are not in the nature of rentals, but represent a charge imposed on the lessee as consideration for being freed early from their obligations under the lease. Where the assets leased are used as capital assets in the lessee’s business, as is usually the case, the lease itself is such a capital asset (see RTZ Oil & Gas v Elliss, 61 TC 132, especially page 172, BIM35420) and an exit charge of this kind would be capital (see for example Mallet v Staveley Iron & Coal Co, 13 TC 772 and BIM35625).

Whether a payment is an adjustment of past rentals or is capital in nature will depend on the facts of individual cases. For example

  • a payment calculated by discounting future rentals due and by taking into account the value of the asset on the premature termination would normally be revenue,
  • a termination payment equal to total undiscounted future rentals, otherwise payable over a considerable period, would prima facie contain a capital element,
  • an adjustment reflecting an enhancement of the lessor’s return on their investment to compensate for, say, additional administrative costs or reinvestment risk would be consistent with the view that an exit charge was wholly an adjustment of past rentals and therefore wholly revenue.