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HMRC internal manual

Capital Gains Manual

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HM Revenue & Customs
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Hire purchase: multiple agreements: challenging transactions

Where you need to consider the tests will be in any case where:

  • if the documents are looked at separately, they produce one tax result

but

  • if the documents can be taken together, they form a single composite transaction which produces a different result which may be less advantageous. An example of this can be found below.

You need to make sure that you obtain ALL the documentation before agreeing that you have a series of transactions where this would result in a tax advantage for one party or the other.

These instructions take you through an example which gives you some idea of the sort of tax advantage that can be achieved.

 

Example of multiple agreements which provide a tax advantage

A sale and leaseback agreement is treated as a part disposal of an asset, TCGA92/S42 (2), see CG70774.

An asset is not disposed of under an option agreement until the option is exercised, TCGA92/S144, see CG12300+.

The example looks at what can happen when these two situations are combined to produce a tax advantage.

Facts

X Ltd owns an asset and disposes of it to Z PLC under a sale and leaseback agreement. At the same time, Z and X enter into an option agreement which allows X to repurchase the asset at the end of the lease period.

This type of agreement is commonly entered into as a form of financing arrangement. It provides the vendor (X) with finance at the outset, allows X continued use of the asset and the opportunity to repurchase the asset at the end of the lease.

So far as Z is concerned, it provides a guaranteed stream of income and an asset which can be sold either to X, if the option is exercised, or someone else, if it is not. However, it can also provide X with a tax advantage.

In this type of case, there will normally be either two or three separate agreements. There will be:

  • a sale agreement*
  • a leaseback agreement*

and

  • an option agreement.

*These may well be in the same agreement.

Under the rules for sale and leaseback, when the asset is sold, X is treated as making a part disposal. In arriving at X’s gain or loss, A in the A/A+ B computation is the actual disposal consideration while B is the value of X’s retained interest. Z has acquired the asset subject to X’s retained interest.

Under the rules for options, Z will not dispose of its interest in the asset until X exercises the option at the end of the lease period. If, as was the case in the examples we have seen, the original part disposal enabled X to claim a relief or exemption, X has gained a tax advantage.

Linking the agreements

To deny X its tax advantage, you have to be able, using the tests which CG12880 tells you about, to link:

  • the sale agreement

and

  • the leaseback agreement

and

  • the repurchase agreement.

If you can do this, then these are treated as a single composite transaction.

Treating the transactions as a composite means that the vendor, X, retains beneficial ownership of the asset throughout the period between the original sale and the repurchase. As Capital Gains Tax is based on beneficial ownership, see CG10720, this means that X never disposed of the asset for Capital Gains Tax purposes. The fact that legal ownership may have passed during this period does not mean that a disposal has taken place. X cannot, therefore, have the advantage of the claimed loss.

Option lapses

In the example, it was assumed that X exercised its option and repurchased the asset. It has, therefore, gained a tax advantage at perhaps little or no cost since many of these arrangements deduct the leasing fees from the repurchase price. However, if X had not taken up the option to repurchase or if this had lapsed, it would still be treated as having made a part disposal of the asset at the date of the original agreement.

Assessments

Since the consequences of a series of agreements may not become apparent for some time, you should always make any necessary Capital Gains Tax assessment at the outset. Where a loss arises, see CG15800+.