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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not long funding leases: sale and leaseback: example - accounting treatment where sale recognised; part 2 of 3

The following example is correct for sale and finance leaseback transactions occurring before 9 October 2007. See BLM35026 for changes

This is the accounting under FRS102, IAS 17 and FRS101 and the first method in the Guidance Notes to SSAP 21.

This accounting method treats the asset as sold and the profit amortised over the lease term, and then accounts for the finance lease as a separate transaction. The accounting entries are:

Dr bank   30,000
Cr asset   25,000
Cr deferred income (profit on sale)   5,000
Dr leased asset   30,000
Cr finance lease liability*   30,000
Annual entries in profit and loss a/c in each of Years 6 - 10    
Debit depreciation of leased asset   6,000
Credit 1/5th x profit on sale of asset (30,000 25,000)   (1,000)
  • The tax legislation generally refers to accounting ‘as a finance lease or loan’ as it might be argued that the finance lease liability is presented as a loan in the accounts.

In other words, the trader is treated for accountancy purposes as if he had first acquired the asset under a finance lease at the end of year 5 for £30,000 and that cost is written off over the remaining five years of useful life; that is, there is a depreciation charge of £6,000 a year for five years.

Tax consequences

The tax consequences if this accounting treatment is used and the asset is treated as sold and profit written off are:

  • the profit on sale (£1,000 pa) is a capital profit - as it is included in the commercial profit, it must be deducted to arrive at the taxable profit;
  • for leases written up to 8 October 2007 the capital allowances disposal value will be restricted under CAA01/S222, see CA28550
  • following FA 2004, for leases written up to 8 October 2007 the deduction for rentals under the leaseback will be restricted under CAA01/S228B, see CA28920
  • there will not be a chargeable gain as the sale proceeds were less than cost and are dealt with through the capital allowances computation.

If the asset had been sold and leased back for £20,000, there would be a loss on sale of £5,000. The net accounting entry would still have been £5,000 each year (rent/depreciation £4,000 plus loss on sale of £1,000). But the loss on sale should be excluded for tax purposes, leaving only the annual rent (described as depreciation) of £4,000 per annum (£20,000 over 5 years) deductible prior to FA 2004. Following FA 2004, and assuming (pre 9 October 2007 leases only) there was a restricted disposal value under CAA01/S222, the deduction for the rentals will be restricted under CAA01/S228B for pre 9 October 2007 leases.