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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not long funding leases: finance lessors: general taxation issues: 'income-into-capital' schemes - what the lessee's payments are for

Where the transaction is treated as a finance lease or loan in the lessee’s (unconsolidated) accounts, it may often be appropriate to look critically at the make-up of the lessee’s interest or finance charge in cases of this kind. Finance charges (the ‘interest’ element of the rentals) are calculated on the current balance outstanding under the finance lease or loan at the rate of interest implicit in the lease. But in some circumstances the finance charge may not wholly represent rentals for the lease of the asset and may be partly capital in nature.

For example, if part of the finance charge is calculated by estimating the capital sum the option-holder will have to pay upon exercise of the option to purchase the lessor’s interest in the asset and apportioning part of that sum to accounting periods falling before the option exercise date. The exercise of the option would involve the acquisition of an asset, which is a transaction of a capital nature. To the extent that the expenditure when incurred will be capital expenditure, the annual provision is analogous to a provision for depreciation of capital expenditure. No deduction can be made in respect of such a provision by virtue of CTA09/S54 / ITTOIA05/S33. Authority for this position may be found in RTZ Oil and Gas Limited v Elliss 61TC132; BIM35420

It is also possible that in some cases the rate used in calculating the finance charge in the accounts is not the rate implicit in the lease but some other, possibly higher, rate such as a money market rate for equivalent borrowing.