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HMRC internal manual

Business Leasing Manual

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HM Revenue & Customs
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Taxation of leases that are not long-funding leases: sale and leaseback: example - accounting where sale not recognised; part 3 of 3

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

Where the sale is not recognised the accounting treatment regards the transaction purely as a refinancing exercise. The asset is not treated as if it had been sold and the profit on sale is not taken. The asset stays in the vendor’s balance sheet at its book value and the sale proceeds is shown as a creditor. The accounting entries are:

  £  
     
Dr bank 30,000  
Cr finance lease creditor* 30,000  
  • The tax legislation generally refers to accounting ‘as a finance lease or loan’ as it might be argued that this liability is presented as a loan in the accounts.

At the end of Year 5 the asset is in the balance sheet at its written down value of £25,000 (cost £50,000 less depreciation £25,000).

Annual entries in profit and loss account in years 6 to 10 are limited to

  • the depreciation of asset as before:

(10 % x original cost of 50,000) = 5,000

  • plus the finance charge element of the lease rentals

Tax consequences

Under the new finance lease, the capital repayment element in the rentals total £30,000 and this is payable over five years (Years 6 to 10 inclusive). The asset will be worth nothing at the end of ten years and so the full amount of these rentals has to be written off over this period. But, because the asset has stayed in the balance sheet at its existing written down value of £25,000, the actual depreciation charge will only write off £25,000 by the end of year ten - a shortfall of £5,000. Prior to FA 2004, to find the allowable revenue rental deduction each year you use the actual rate of write off in the accounts as a guide. That is, multiply the total capital repayable (£30,000) by

the actual depreciation each year (£5,000) = 1/5th or 20 %.

the total amount of actual depreciation to be written off (£25,000).

  • In this example 20% of the total capital element in the rentals (£30,000) is allowable for tax purposes each year, namely £6,000.
  • Depreciation of £5,000 is actually charged in arriving at the commercial profits each year. So a further £1,000 a year must be deducted in the tax computation.
  • There has actually been a sale and so there will be a capital allowances disposal event. (There will not be a chargeable gain as the sale proceeds were less than cost and are dealt with through the capital allowances computation).

Following FA 2004, for pre 9 October 2007 leases only, and assuming there was a restricted disposal value under CAA01/S222, the deduction for the rentals will be restricted under CAA01/S228B.

If the sale and lease-back was for £20,000 rather than £30,000, the accounting entries would be unaffected. The charge to profit and loss would be £5,000 per annum. But this would have to be adjusted for tax purposes to add back the amount of the depreciation that represents the capital loss on sale of the asset (£5,000), the amount disallowed being £1,000 for each of the 5 years of the finance lease. Following FA 2004, for pre 9 October 2007 leases only, and assuming there was a restricted disposal value under CAA01/S222, the deduction for the rentals will be restricted under CAA01/S228B.