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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not long funding leases: leases with option for lessee to purchase the leased asset: whether lessee incurs capital expenditure

A typical hire purchase contract looks very like a finance lease except that it either:

  • provides for the asset being hired to become the property of the lessee automatically at the end of the hire period, or
  • gives the hirer an option to buy the asset for a specified price (often a nominal amount).

The seller retains ownership until the hire purchaser has fulfilled the conditions specified in the agreement.

It might be thought that as the lessee in such a contract is just that - a lessee - the payments are all on revenue account and that no capital expenditure is incurred. However, payments under a hire purchase contract are made up of

  • revenue payments for hire of the asset, which are deductible in calculating the lessee’s taxable profits, and
  • capital payments for the purchase of the asset (or for the option to do so), which are not deductible but which may qualify for capital allowances under CAA01/S67, see CA23310 onwards.

That the payments should be split in this way was confirmed in the case of Darngavil Coal Co Ltd v Francis (7TC1), although it gives no guidance on how to apportion each payment between the revenue and capital components. You should, however, accept that in a typical hire purchase contract (where the payments are spread evenly over the term of the lease) the lessee incurs capital expenditure as soon as the first instalment is paid.

A lease contract with an option for the lessee to acquire the asset falls within CAA01/S67 if the option to acquire the asset is below the expected market value of the asset at the date the option is exercised. This is because, following the principle in Darngavil, the payments under the lease contain an element that is regarded as capital.

Transactions that fall within the scope of CAA01/S67 cannot be long funding leases (CAA01/S70J (3)).

Guidance on contracts with market value options is at BLM39015 (operating leases) and BLM39020 (finance leases).