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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not long funding leases: finance lessees: termination adjustments: adjustments needed for tax purposes

Where GAAP has been followed for tax purposes (as should almost always be the case) no adjustments to the lessee’s profits are needed; the accounting treatment is followed for tax purposes. The terminal rebate will be credited in the accounts applying recognised accountancy practice. In the first instance it will be set against any balance of rents not yet relieved (the finance lease asset). If the receipt exceeds this, there will be a credit as a profit on the sale of a fixed (leased) asset. All you have to do is to ensure that this is not excluded from the taxable profit in the tax computation because, in reality, it is a (taxable) refund of rentals that have been allowed as an expense in an earlier period.

Consider the example at BLM15540 in which the lease is terminated early on the first day of the fifth year. The book value of the asset then is £40,000. The sale proceeds are £42,000 of which £400 is absorbed by the lessor’s handling charge. The lessee gets credit for £41,100. This consists of cash received of £29,100 plus credit against outstanding liability of £11,600 and an additional interest charge of £400). The £41,100 is utilised as follows:

  • £40,000 is offset against the rent as yet unrelieved (the two items cancel each other out: the lessee gets no further deduction for rent paid, nor is he taxed on the recovery)
  • £1,100 is the profit on the termination of the lease and disposal of an asset and is credited to the profit and loss. Just as the depreciation charged on leased assets represents a revenue expense (rent) and is not added back, so the rebate represents a revenue receipt and is not excluded from the tax computation.