Plant and machinery leasing - Anti-avoidance: Long funding lease / Non-long funding lease interaction: Mismatched lease chains
A business may act as an intermediate lessor, leasing in plant or machinery under one lease and leasing it out under another. Where the leases are in substance only providing funding then commercially the intermediate lessor is just taking an ‘interest turn’.
Leases commencing on or after 1 April 2006
Following the introduction of the long funding lease rules in 2006 some parties entered into lease chain arrangements structured to exploit the differences between the long funding and non long funding lease rules.
One such arrangement involves a lease and leaseback where the Head lease is not a long funding lease but the leaseback is. The consequence of the arrangement was that the intermediate lessee was taxable only on the interest element of the rentals under the leaseback (for companies by reason of section 502B ICTA 1988 if a finance lease and by reason of section 502E ICTA 1988 if an operating lease) but were able to claim a deduction for the full rental paid under the non long funding head lease.
Section 502B ICTA 1988 has now been rewritten to section 360 CTA 2010 and section 502E ICTA 1988 has been rewritten to section 363 CTA 2010.
Company (H) owns and leases plant and machinery under non long funding lease to Intermediate lessor
- H is taxed on the full amount of rentals but can claim capital allowances
Intermediate lessor (L) leases plant and machinery to S under a long funding lease
- L is taxed on finance element of receipts only, but claims a deduction for the full rental
Sub-lessee (S) uses the plant and machinery leased from L in its trade
- S gets a deduction only for the finance charge element of the rentals that it pays and is not entitled to capital allowances unless H cannot claim them (section 70Q CAA 2001)
However, it was usually the case that the sub-lessee was not tax resident in the UK and would be able to claim relief in its home jurisdiction, or was otherwise outside the charge to UK tax.
Legislation effective from 13 December 2007
As the above mismatch could arise in a number of ways, the legislation to combat it addressed the issue in the following ways:
Non-long funding head lease, with a long funding sub lease, entered into on or after 13 December 2007
Legislation introduced at section 502GB ICTA 1988 for companies (and section 148FB ITTOIA 2005 for income tax payers) prevented the intermediate lessor from benefiting from the restriction of the lessor’s rental earnings at section 502B ICTA 1988 when the sub lease was entered into on or after 13 December 2007. This left the intermediate lessor taxed as though the sub lease was a non long funding lease, i.e. they were taxed on the full sub lease rentals received, with a deduction for all lease rentals paid under the non long funding head lease.
Section 502GB ICTA 1988 has now been rewritten to section 372 CTA 2010 for accounting periods ending on or after 1 April 2010.
Non long funding head lease, with a long funding sub lease, entered into before 13 December 2007
Section 502GB ICTA 1988 for companies and section 148FB ITTOIA 2005 for income tax payers did not apply wholly to sub leases in place before 13 December 2007, however the unintended tax benefits were ceased going forward. This was done by paragraph 11, Schedule 20 FA 2008 which applies to sub leases in place before 13 December 2007 as follows:
- Where a period of account begins on or after 13 December 2007, and no rentals due under the sub lease before that date are in respect of that period, then section 502B ICTA 1988 (section 148B ITTOIA 2005) does not apply.
- Where a period of account ends after 13 December 2007 (but the conditions in the previous bullet are not met) the lessor is treated as receiving income in addition to the amount recognised under section 502B ICTA 1988 (section 148B ITTOIA 2005). In such a case the amount of the income brought into account is the capital element of the rentals due on or after 13 December 2007, but only insofar as they refer to the periods after 12 December 2007.
In effect paragraph 11, Schedule 20 FA 2008 acted to ‘add back’ an amount of income equivalent to that which was restricted under section 502B ICTA 1988.
Paragraph 11, Schedule 20 FA 2008 still applies to income tax payers but for companies the legislation was rewritten to paragraph 62, Schedule 2 CTA 2010 for accounting periods ending on or after 1 April 2010.
Head lease would be a long funding lease but for section 70H CAA 2001
Section 70H CAA 2001 was also amended via subsections (1A) and (1B), for leases entered into on or after 13 December 2007. This ensures that an intermediate lessor cannot opt to treat a long funding lease, of which it is the lessee, as a non long funding lease by choosing not to make a tax return on that basis, in cases where they are a sub lessor of any of that same equipment and that sub lease is a long funding lease.
Existing legislation at section 70Y CAA 2001 prevents a lessor of plant or machinery under a long funding lease from gaining a tax advantage by subsequently entering into a sale or lease and leaseback transaction with the same equipment. Section 70Y CAA 2001 acts to ensure that any superior leases created under such an arrangement, whether direct or indirect, are deemed to be long funding leases for all parties involved so there will be no superior lessor entitlement to capital allowances.