OT21564C - Investment Allowance: Operating and leasing expenditure – Restrictions

There are certain circumstances in which excessive allowance could be generated when leasing expenditure is incurred. This could happen in situations where sums are received by the lessee in respect of the lease. This could include, but is not limited to, refunds of lease payments, compensation, or disposal proceeds if the lease is sold. Excessive allowance could also be generated in some situations where the lease is sub-let. To deal with these situations certain restrictions apply.

Regulation 5 deals with situations where a lessee receives amounts in respect of a lease. Lessors of a lease will not need to consider this regulation.

Regulation 6 deals with situations where an asset is subleased. The lessor and lessee will need to consider the impact of this regulation together.

Anti-avoidance provisions are contained in Regulation 7

Lease amounts (Regulation 5)

In certain scenarios, including where a lease is sold or is terminated early, a lessee may receive from the lessor, or another party, a payment in respect of the lease. This could include a refund of leasing expenditure, compensation in respect of the lease or disposal proceeds on sale of the lease. The legislation describes any such sums received as ‘lease amounts’.

Where ‘lease amounts’ are received, the amount in respect of which allowance is generated could exceed the true economic value of the investment. For example, if leasing expenditure totalled £1,000 and allowance is generated on that amount, but £200 is subsequently refunded, then the amount on which allowance was generated would exceed the true economic value of the investment of £800.

To deal with this kind of situation, the rules require any leasing or operating expenditure to be set against any ’lease amounts’ received in the year or in any previous year, before any further allowance can be generated.

What is a ‘lease amount’?

The legislation is broadly written to capture almost any payment made to the lessee of a qualifying lease in respect of that lease. This would include (but is not limited to) a refund of lease payments, compensation paid to the lessee in respect of the lease or consideration received on sale of the lease.

However, where the lessee has sublet the asset, lease rental payments by the sub-lessee to the sublessor are not lease amounts in the hands of the recipient for the purposes of these regulations, even though they are made in respect of a lease.

It is explicitly stated in the regulations that sub-lease payments between connected parties are not lease amounts. Sub-lease payments between unconnected parties are also excluded from the rules because the sublease will not be a qualifying lease as defined, from the perspective of the sublessor, as the company or a connected party will not be the lessee in respect of that lease.

All other payments paid to a lessee (including a sub-lessee) in respect of a lease will be lease amounts.

How are ‘lease amounts’ treated?

Any ‘lease amounts’ received by a company and its associates are pooled and set against any expenditure which would otherwise be operating or leasing expenditure which the company (or its associates) incurs in the period in which the leasing payment is received, or in any subsequent period.

Associated companies

The rules on lease amounts in regulation 5 apply to associated companies. Associated companies are defined at s271 CTA 2010. Guidance on when companies are associated for these purposes can be found in the Oil Taxation Manual at OTM21010.

Where a company incurs operating or leasing expenditure which meets all the conditions in the legislation, in order for investment allowance or cluster area allowance to be generated the expenditure must exceed not only the lease amounts received by the company incurring the expenditure but also any lease amounts received by associated companies, which have not previously been set against operating or leasing expenditure incurred by either of those companies or any other associated company.

Sub-Leasing Restriction (Regulation 6)

When a lease is sub-let, the sub-lessee may generate the allowances in respect of lease expenditure they incur, subject to all other conditions being met. During the period of the sub-lease, the sublessor will not be able to generate allowances in respect of that asset, as the asset will not be being used for the purposes of the sub-lessor’s ring fence trade. However, the sub-lessor may generate allowance during the period when the asset is not sub-let, provided that the asset is being used for the ring fence trade and satisfies all other conditions.

This could lead to excessive allowance being generated if the sublease leasing expenditure is higher than the head lease. This could be because payments under the head lease were front-loaded or there were ‘balloon payments’ at the end of the head lease, so that allowance was generated on the excess amounts before or after the lease was sub-let. To prevent excessive allowance being generated, the amount of leasing expenditure under a sub-lease that can generate allowance has been capped at the amount of leasing expenditure paid under the head lease during the same period. This restriction will only have effect for sub-leases taken out after 29 March 2017 when the legislation came into force.