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HMRC internal manual

Business Leasing Manual

Plant and machinery leasing - Anti-avoidance: Non-long funding lease rules: Finance leaseback - Lessor income restriction - termination of lease

Note - Section 228E CAA 2001 was repealed for transactions entered into on or after 9 October 2007.

Normally when a lessor sells an asset the disposal proceeds brought to account cannot be more than the qualifying expenditure section 62 CAA 2001. In a sale and finance leaseback case the qualifying expenditure is restricted to the lower of market value and notional written down value. So both the amount that the lessor spent on the asset and its selling price may be more than the qualifying expenditure.

Terminations on or after 17 March 2004

When a leaseback terminates, the lessor may sell the plant and machinery that had been subject to the lease. Depending on the disposal proceeds, this may then result (subject to the terms of the lease) in a refund of some of the rentals paid by the lessee.

For terminations on or after 17 March 2004 section 228E CAA 2001 applied to limit the deductions due to the lessor for the refund of rentals to the lessee. Section 228E CAA 2001 was applicable to where:

* the leaseback terminates,
* the lessor disposed of the plant and machinery. And
* the amount of the disposal value required to be brought into account was restricted by section 62 CAA 2001.

As the refund of rentals was based on the sale price rather than the disposal value brought to account so the deduction for the refund was based on that disposal value rather than the sale price.

If the lessor’s disposal value was restricted by section 62 CAA 2001 then the refund of rentals could only be deducted in computing income to the extent it was not more than the disposal value brought to account in the capital allowance computation.

Example

Roland sold an asset to Oliver for £20,000 and leased it back over 10 years for £2,000 a year. When Roland sold the asset to Oliver his disposal value has been restricted by section 222 CAA 2001 to £1,000. This means that Oliver’s qualifying expenditure was £1,000. Roland terminates the lease after two years and Oliver sells the asset for £18,500. Roland has to pay a termination charge of £16,000, which represents the outstanding lease rentals. Oliver then gives Roland £18,000 as a refund of rentals. As Oliver’s disposal value is restricted to £1,000, he can only deduct (via section 228E CAA 2001) £1,000 of the £18,000 in computing his profits for tax purposes.

Transactions entered into on or after 9 October 2007

Section 228E CAA 2001 was repealed for transactions entered into on or after 9 October 2007.