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HMRC internal manual

Business Leasing Manual

HM Revenue & Customs
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Taxation of leases that are not long funding leases: finance lessees: termination adjustments: sale of asset by lessor to lessee

If the asset is sold by the lessor to the lessee at the end of the primary lease period, the only change in terms of presentation in the accounts may be that the leased assets should be separately identified in a note to the accounts. But clearly something has changed. The amount shown in the balance sheet now represents an interest in something for which legal title is now held. The main problem this raises is what happens to the unrelieved lease rentals (equal to the book value of the leased asset in the lessee’s accounts). In practice you should accept that the tax treatment of the unrelieved lease rentals follows the correct accounting treatment.

Consider the example at BLM15505 (particularly at BLM15535). At the end of the fifth year the loan implicit in the lease has been repaid. However the lessee’s interest in the asset remains on the balance sheet in the form of rentals that have not yet been written off (£37,500). If, on the first day of the sixth year, the lessor and the lessee tear up the lease agreement and transfer legal ownership of the asset to the lessee, it is arguable that

  • no further revenue deduction is available for payments under the lease - as the (former) lessee now has outright ownership of the asset, these must be capital expenditure,
  • payments under the lease are not eligible for capital allowances - they are not expenditure in consequence of which the plant or machinery belongs to the user.

The legal position is uncertain and, whilst it is not absolutely clear that relief for the rents is available, the better view is that the rents have been paid and that the lessee remains entitled to a deduction for them.

The better course is therefore to allow a deduction for tax purposes by following the accounting treatment of the unrelieved rentals. However, if you come across evidence of someone trying to exploit this uncertainty to produce a result that creates some tax advantage for the taxpayer, please let CTISA (CT&BIT) know.

It would also be easy to carry out the transaction by the lessor selling the asset for its market value to the lessee. The effect would be that the former lessee might pay £37,500 for the legal title (on which capital allowances might then be claimed) and receive a £37,500 (or thereabouts) rebate of rentals which offsets the unrelieved rents.