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HMRC internal manual

Business Leasing Manual

Sale of lessor companies and similar arrangements: introduction and background: background

A lease of relatively long-lived plant or machinery typically generates tax losses in the first years, because the capital allowances outstrip the income from the lease, and goes on to produce tax profits in the later years, because the capital allowances were then exhausted.

The availability of capital allowances to lessors has been restricted by the long funding lease rules introduced by FA 2006 but capital allowances are still available on leased plant or machinery, either because the leases pre-date the long funding lease rules or because they are outside those rules.

Note also that the issues described here are as likely to arise on, for example, the 7-year lease of a ship as they are on a 25-year lease of that ship.

Groups took advantage of the early tax losses by surrendering them as group relief. A group looking to maximise the tax advantages would then sell the lessor company to a loss making group as the lease moved into the tax profitable phase. The new group surrendered its losses to the lessor company so that no tax was payable on the deferred profits. Where the new owner was a long-term loss-maker the effect was to turn the capital allowances timing advantage into a permanent deferral of tax.

Often, the lease would be terminated in the hands on the loss-maker and the leased asset sold. The tax profit on selling the asset was covered by losses surrendered by the new owner group.

The sale of lessors legislation deters this transaction by treating as income an amount which reflects the timing advantage gained from the capital allowances while the lessor company is in the ownership of the selling group. On its own this would deter all sales of lessor companies but the legislation goes on to treat the lessor company as incurring an expense equal to the income amount while the lessor company is in the ownership of the buying group.

When the buying group has profits the expense is valuable, it may generate losses which are available to surrender as group relief. The profit making buyer is not deterred from buying and is likely to pay more for the shares in the lessor company, compensating the seller for the tax charge suffered. When the buying group has losses the expense brings no benefits and the buying group will pay no more for the shares, leaving the seller exposed to a charge. This sale becomes unattractive and is deterred.

The legislation operates in a similar way where the arrangements are intended to allow a profitable partner to access the tax losses and a loss-making partner to shelter the taxable profits.