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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not long funding leases: finance lessees: importance of lease term: introduction

The period over which a leased asset is depreciated is significant for tax purposes because the depreciation is, in effect, allowed as a deduction in computing profits.

Finance leases of large (and therefore expensive) assets tend to be written for fairly long periods. Because the finance lessee owns the asset in economic terms but the lessor retains legal title, the lease agreement normally provides for the lessee to carry on using the asset for its full useful life.

However finance leases are sometimes written for periods that are far shorter than the economic life of the asset. For example, the lessee may want a financing style arrangement, but equally knows at the outset that the asset will not be used for its full life. If the lessor is overseas, the lease may be designed to satisfy the regulatory requirements in the lessor’s country.

In such circumstances you would expect to see the lessor being required to sell the asset at the end of the lease term and paying almost all (usually more than 99%) of the sale proceeds to the lessee as a rebate of rentals.

In the vast majority of cases, however, the lease will contain an option for a secondary period, even if the lessee does not expect to use it. Note that, in this case, the term of the lease (for accounting and tax) will be the period ending at the end of the primary period. But that does not mean the lessee is necessarily entitled to a deduction for all the lease rentals payable for the period.

Guidance on the possible tax issues to consider where there is no secondary lease period is given in the following paragraphs:

  • where the primary lease period equates to the useful life of the asset, see BLM32515
  • where the primary lease period is less than the useful life of the asset, see BLM32525.

Where there is a secondary lease period, but rentals are wholly written off over a short primary period, see BLM32540.