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HMRC internal manual

Business Leasing Manual

Plant and machinery leasing - Anti-avoidance: Long funding lease rules: Disposal values: Lessee disposal value at the end of a long funding lease with market value options

If a long funding finance lease is structured as a full payout lease, the lease payments would normally fully cover the lessor’s capital costs. However some full payout leases are structured so that the capital cost, rather than being repaid over the life of the lease, is due at the end in a final balloon payment.

In some leases there may also be the inclusion of a market value purchase option that may be exercised instead of incurring the final payment. The lessor would still receive the same amount, either as a final payment or as a combination of market value sale proceeds plus a residual value guarantee, from the lessee.

Disposal events on or after 1 April 2006

Prior to 13 November 2008 an issue arose with the disposal value given by section 70E CAA 2001 where such a purchase option was exercised.

On commencement of the lease:

* the lessee was able to claim capital allowances on the full value of the minimum lease payments, this includes the final balloon payment (section 70YE CAA 2001).

If the lessee exercises the option:

* the lessee does not make the balloon payment.
* the lessee incurs new qualifying expenditure on the amount paid to purchase the asset under the market value option.

The lease is terminated

* the lessee has not made the balloon payment but section 70E CAA 2001 does not act to bring in a disposal value that reflects the fact that this final lease payment was never made.
* the lessee’s disposal value calculated under section 70E CAA 2001 for a lease that does not terminate early is limited to any amounts calculated by reference to the termination value payable to the lessee, and then reduced by any sum payable by the lessor to the lessor for the termination. As the lessee has not terminated the lease early (the option is only exercisable on termination) and has received nothing the disposal value will be nil (the disposal value cannot be less than nil).

This created a mismatch meaning the lessee received relief in excess of their expense.

Example

There is a long funding finance lease with a market value option. The cost of the asset was £100 and only ‘interest’ is paid over the lease term with a final lease rental of £100 due as the final payment. The market value of the asset at the end of the lease term is £80 and that this is the point at which the market value option can be exercised. Under the long funding lease rules the lessee will be entitled to claim capital allowances on £100 at the commencement of the lease.

At the end of the lease term -

  • if the market value option is not exercised then the lessee will pay a termination rent of £100 and (assuming that the lessor sells the asset to a third party for the market value) it will receive a rent rebate of £80. The disposal proceeds to be brought in under section 70E CAA 2001 will be £80. The lessee will have obtained capital allowances on their net expenditure of £20. This is the desired result.
  • if the market value option is exercised, the lessee will pay £80 to the lessor under the market value option and will not pay the final lease rental instalment of £100 - instead it will pay just £20 under the lease as a residual value guarantee. This time under section 70E CAA 2001 the disposal value is nil - no rental rebate has been received. However, the lessee has now purchased an asset at market value for £80 and is entitled to claim capital allowances on that sum. So in these circumstances the lessee will be entitled to claim capital allowances on expenditure of £180 (the £100 deemed acquisition cost plus the £80 acquisition expenditure under the market value option) where they have only incurred capital expenditure of £100.

Disposal events on or after 13 November 2008

From 13 November 2008 section 70E CAA 2001 was amended. For disposal events occurring on or after this date the disposal value is determined by the formula

(QE - QA) + R

where—

QE is the person’s qualifying expenditure on the provision of the plant or machinery;

QA is the qualifying amount- representing the capital payments made; and

R is any relevant rebate