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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not non funding leases: finance lessees: importance of lease term: lease with secondary period: rentals wholly written off over short primary period - depreciation period

Under GAAP a leased asset is depreciated over the shorter of its expected useful life and the term of the lease unless it is reasonably certain the lessee will obtain ownership of the asset at the end of the lease term, in which case the asset is depreciated over its expected useful life. The term of the lease should include secondary periods where, at inception, it is ‘reasonably certain’ that the lessee will exercise the option to extend the lease into the secondary period (see BLM11015). In an arm’s length deal, a lessee will not be prepared to pay the full cost of buying the asset, plus interest, without either securing the right to use the asset for as long as it lasts or the right to be paid the market value of the asset when the lease ends.

Where there are secondary periods, and the asset is expected to have significant residual value at the end of the primary period, you should therefore normally contend either that

  • it is ‘reasonably certain’ at the inception of the lease that the lessee will not exercise the right to terminate it at the end of the primary period; and
  • the asset should be written off over the shorter of its useful life and the term of the lease including secondary periods.

Alternatively, if the lessee is able to show that extension of the lease into secondary periods is not ‘reasonably certain’, the depreciation charge should reflect the value of the asset on termination (which will be rebated to the lessee).

If necessary you should seek the views of your local advisory accountant on the commercial acceptability of the accounting treatment used.