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HMRC internal manual

Business Leasing Manual

From
HM Revenue & Customs
Updated
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Calculating the income amount: Calculating the income amount: introduction

The income amount takes the tax timing benefit derived from the capital allowances away from the selling group.

When the lessor company buys a plant or machinery asset for its leasing business it records the cost of the asset on its balance sheet either as a plant or machinery asset or by reference to the value of the company’s net investment in the lease. The accounting treatment is determined by whether the lease is an operating lease or a finance lease. Where the lease is an operating lease the cost of the asset will be shown on the balance sheet and written down over its expected useful economic life. Where the lease is a finance lease the net investment in the lease is shown on the face of the accounts and the amount is written down over the term of the lease.

For tax purposes the company will claim capital allowances on the cost of the asset. Capital allowances are given on a reducing balance basis. Historically allowances were available at 25% so that after 8 years the written down value would have been negligible.

Whenever the asset or the lease had a life in excess of 4 years, and assuming the assetwas depreciated on a straight line basis, the rate at which the asset was written off for tax purposes would, at least initially, outstrip the rate at which it was written down for the purposes of stating the commercial profit.

At any point in time there will be a difference between the value of the asset for tax purposes and the value of the asset in the commercial accounts (see the examples below). The sale of lessors income amount seeks to recover the value of the difference where the tax written down value is less that the value in the accounts.

This is illustrated by the following graphs.

Example 1: Graph showing difference between tax written down value and accounting value for a fixed asset with an expected life of 10 years and capital allowances available at 25%

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In this example the asset is written down in the accounts on a straight-line basis over its useful economic life of 10 years. The tax write down profile means that the values diverge markedly for most of the 10 years.

Example 2: Graph showing difference between tax written down value and net investment in a finance lease with a term of 10 years and capital allowances available at 25%

In this example the asset is represented by the net investment in the lease. This time the profile is not straight-line, reflecting the nature of the finance lease. The tax write down profile again means that again the values diverge markedly for most of the 10 years.