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HMRC internal manual

Business Leasing Manual

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HM Revenue & Customs
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Taxation of long funding leases: long funding operating lessors: additional capital expenditure

If the lessor incurs further capital expenditure on the asset, it will not qualify for capital allowances. This is because CAA01/S34A applies to this additional expenditure as it does to the original expenditure (by virtue of the existing CAA01/S571) and prevents expenditure on an asset acquired for the purposes of leasing under a long funding lease from being qualifying expenditure for capital allowances purposes.

In this situation CTA10/S366-368 apply to further reduce the lessor’s income for tax purposes, reflecting the fact that further expenditure has been incurred for which no relief would otherwise be available.

The effect of this section is shown in the following example.

Example

A plant or machinery asset cost £20,000. It is leased out under a long funding operating lease for 15 years at a rent of £1,300 per year. It is expected to have a value of £5,000 at the end of year 15. The lessor incurs further capital expenditure of £5,000 at the end of year 5 and increases the rental by £600 a year. At the end of year 5, and following the additional capital expenditure, the expected market value at the end of year 15 is £6,000.

CTA10/S363-365

  • The starting value = £20,000,
  • The expected residual value = £5,000,
  • The gross expected reduction in value = £15,000,
  • The annual deduction in each of the 15 years of the lease = £15,000 / 15 = £1,000.

CTA10/S366-368

  • At the end of year 5, the expected value at end of year 15 (ARV) = £6,000,
  • The original expected residual value (CRV) = £5,000,
  • The sum of any amounts that fell to taken into account as RRV (see below) in respect of previous additional expenditure (PRV) = 0,
  • TRV = CRV + PRV = £5,000,
  • ARV (£6,000) exceeds TRV (£5,000) and so RRV = £1,000,
  • The expected partial reduction is the additional expenditure (£5,000) less the RRV (£1,000) = £4,000;
  • This results in an additional deduction in years 6 to 15 of £400 a year.

The end result - assuming no other changes - is that the lessor obtains deductions of:

Years 1 - 5: 5 x £1000 = £5,000
     
Years 6 - 15: 10 x £1,400 = £14,000

The total cost was £25,000 and a total of £19,000 is relieved. Assuming the asset has a value of £6,000 at the end of the lease term that is clearly the appropriate result. In practice, as the value is unlikely to be precisely as expected at inception, adjustments are likely to be necessary when the lease terminates, see BLM41035.

For accounting periods ending before 1 April 2010.

For accounting periods ending before 1 April 2010 the relevant legislation was at ICTA88/S502F.