Taxation of leases that are not long funding leases: finance lessees: importance of lease term: lease with secondary period: rentals wholly written off over short primary period - example
Consider the following simplified example:
- an asset which has a cash cost of £300,000 has an expected useful life of ten years,
- the trader leases the asset over a primary period of five years in which rentals (excluding the finance charge element) of £60,000 a year are payable,
- the lessee has the right to continue to lease the asset for as long they like after the primary period on payment of £10 (ten pounds) a year,
- after five years the asset is worth £150,000.
On these facts the £300,000 capital cost of the asset will be consumed over ten years because it is reasonably certain that the lessee will exercise the right to extend the lease period. This produces a depreciation charge of £30,000 each year the asset is leased.
If it is expected that the asset will be sold after five years (which would, commercially, require the lessee to be entitled to receive a rebate of rentals), the residual value at the five year point will be £150,000 and so the net amount to be written off is £150,000 (£300,000 less £150,000) over the five year period (£30,000 a year).