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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: no secondary period: assets with residual values

It is possible for a lease of a chattel (such as an aircraft or ship) to contain no provision for a secondary period although the asset is still very valuable at the end of the primary period. The trader may decide he only needs finance for the ship for ten years but the ship has a 25 year life. In these circumstances the trader (the lessee) is unlikely to be prepared to pay out rentals over the ten year primary period equal to the cost of the ship plus interest on the loan, unless he gets the full economic rights to the asset. So, if there is no provision for a secondary period, there should be provision for the lessee to get a rebate of rentals, when the lease ends, equal to the market value of the ship. See BLM32540 where this is not the case.

If there is provision for the lessee to get a rebate of rentals when the lease ends equal to the market value of the asset, correct accountancy (see BLM32535) requires this residual value to be taken into account in computing the depreciation charge. Although the rentals are still written off over the primary period only, the capital element is written off net of the estimated residual value of the asset. The trader writes off his expected net loss on the asset after deducting the expected sale proceeds. This enables a sensible answer to be reached for tax purposes.

You should not accept that the lessee can write off the entire capital element of the rentals over the primary period simply because there are no secondary periods. To do so would be contrary to GAAP. If it is reasonably certain that the secondary period will be taken up by the lessee then this period forms part of the period over which the lease may be depreciated, see BLM15020.

If necessary, you should seek the views of your local advisory accountant on the commercial acceptability of any failure to take into account the residual value of the asset in this way.