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HMRC internal manual

Business Leasing Manual

Taxation of long funding leases: long funding operating lessors: extension of term of long funding operating leases - example

Example

An aircraft is leased for 15 years under a long funding operating lease at £6m a year. The aircraft cost £55m and was expected to be worth £10m after 15 years. Taxation of lessor and lessee proceeded on that basis. After 14 years the lessee agreed with the lessor that it would lease the aircraft for a further 5 years once the 15-year term was up. The lessee’s rentals were reduced to £3m a year from the beginning of year 15 to take account of the extended term

The estimated value of the aircraft after 14 years was £13m (as expected originally, assuming straight line depreciation) and at 20 years was estimated to be £7m.

Because the rents were varied at the start of year 15 the effective date is the start of year 15.

The lessor is taxed on the basis that

  • the aircraft depreciates by £42m over the first 14 years - thus the periodic deduction under CTA10/S363-365 is £3m a year for the first 14 years (BLM41015), and
  • the aircraft depreciates by £6m over the next 6 years - thus the periodic deduction under CTA10/S363-365 is £1m a year in years 15 to 20.
  • Had the aircraft had an estimated market value of £20m at 14 years and £10m at 20 years the rules would mean the lessor would;

    • be treated as ‘recovering’ £7m after 14 years (this is the difference between the cost of £55m less the periodic deductions of 14 x £3m = £13m and the market value of £20m (CTA10/S369, see BLM41035), and
    • be allowed periodic deductions of £1,666,666 a year (that is £10 m spread over 6 years) in years 16 to 20.

The effect is to tax the lessor on its profit under each deemed lease based on the market value at the end of each deemed lease.