Taxation of long funding leases: long funding finance lessors: example of rental earnings other than finance charges
When a finance lease comes to an end, the lessee benefits from the value of the plant or machinery. For example, assume a finance lease comes to an end early, at a point when
- the lessor’s net investment in the lease is £100,000, and
- the market value of the plant or machinery is £120,000
- and that, under the terms of the lease
- the lessee is required to pay a termination rental equal to the lessor’s remaining net investment in the lease,
- the lessee is entitled to receive a rental refund equal to the full value of the plant or machinery up to the lessor’s net investment in the lease plus 95% of the excess of the value of the plant or machinery over the net investment in the lease at the end of the lease.
So here there would be a termination rental of £100,000 and a rental refund of £119,000.
In practice the lessee may just receive a rental refund of £19,000.
The termination rental, or a combination of the sale proceeds and termination rental, will reduce the lessor’s net investment in the lease to nil.
In this example, £100,000 of the sale proceeds of £120,000 will be used to reduce the lessor’s net investment in the lease to nil. Of the excess of £20,000 the lessor will refund of £19,000 to the lessee. The difference of £1,000 will be reflected in gross earnings and so will be taxed as rental earnings under ICTA88/S502B.
The underlying accounting entries that give rise to gross earnings may show both the £20,000 and the £19,000 or just the net £1,000. But, whichever is the case, only the net £1,000 will be credited in the profit and loss account.
See also BLM410130 regarding the treatment of the £19,000 refunded to the lessee.