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As expected, the Government today introduced the new regime for the
taxation of leasing in the UK. Some of the legislation was published before
today and HMRC expects to publish further legislation before the end of
March. This makes for continuing uncertainty for those lessors trying to
ensure their systems are able to cope with the new regime, which will come
into operation for new leases in 10 days time.
Fundamentally, the new regime gives capital allowances to the economic owner
of plant or machinery rather than, under the current system, to the legal
owner. There are exceptions for ‘short term leases’ where the legal owner
will continue to be entitled to capital allowances.
Under the new regime, the UK’s arguably discriminatory overseas leasing
rules will be abolished and this will open up a new market for UK lessors.
The changes will generally adversely affect the cost of finance provided to
businesses in the UK that use medium and long term leases to lease business
assets.
The ‘funding lease’
A lease is a funding lease if, at the start of the lease, any one of the
following criteria are met:
- It is treated as a finance lease under
generally accepted accounting practice;
- The net present value of the minimum lease
rentals (ignoring payments for ancillary services) is 80% or more of the
market value of the asset; or
- The minimum term of the lease is more than
65% of the expected remaining useful economic life of the asset.
The ‘long funding lease’
A funding lease will be a long funding lease unless it is a ‘short lease’.
A short lease is a funding lease which meets either exception below.
- Lease term no more than 5 years
Where the lease term is less than or equal to 5 years, such leases will be
excluded from being treated as a long funding lease so that both the lessor
and the lessee will be treated in line with the current rules (i.e. capital
allowances available to the legal owner of the asset).
- Lease term is between 5 years and less than
7 years.
Where the lease term is between 5 and 7 years in length, such leases will
also be excluded from being treated as a long funding lease provided:
- the total rentals payable in any year is
not more than 8% of the average amount of rentals payable in the preceding
years; and
- the implied residual value of the plant
and machinery in the lease terms is not more than 5%.
Where the lease is a long funding lease the new regime treats the lessee as
the owner of the equipment for capital allowances purposes. The lessee is also
entitled to deduct the finance charge included in the lease rents. The lessor
is treated as though the lease is a loan and taxed on the finance element of
the rents only. Special adjustments apply where a long funding lease is
accounted for as an operating lease.
The requirement to consider the above tests for every lease a company writes,
and for every lease a business undertakes in order to finance the cost of
equipment means that many lessors in the UK will have to change their systems
to capture the information required to comply with the new regime. As the
complete legislation is still not available, a number of lessors may have
difficulties in changing their systems and procedures in time to capture the
relevant information which will be required for tax purposes when the new
regime fully applies from 1 April.
Transitional rules
Generally, the new regime will not apply to leases where there is a written
contract in place before 1 April 2006, as a result of which the completed
asset is made available to the lessee before 1 April 2006. The transitional
rules apply so that where there is both a written agreement in place before 21
July 2005 and the asset is under construction and not made available to the
lessee before 1 April 2006, as long as the asset is made available before 1
April 2007 (or in special circumstances 1 April 2009), and certain other
conditions are met, the lease will fall within the current regime.
Additionally, where some expenditure is incurred before Royal Assent to FA
2006 and a written lease agreement was in place before 21 July 2005 but the
transitional provisions described above are not met, then expenditure incurred
before Royal Assent will be taxed under the current regime. Any expenditure
incurred after Royal Assent on the same asset will be dealt with under the new
regime if the criteria are met.
Election
Deloitte initiated the call for an election to be available to allow lessors
to elect for all leases to be taxed on the same basis. This would avoid
lessors having to consider the above tests every time they enter into a lease.
HMRC have consequently announced that an election will be introduced which
will allow lessors to elect for all leases (other than car leases) to be taxed
under the new regime where the value of the leased assets does not exceed £10
million (it has not yet been made clear whether this is on a company or group
basis). The election itself may be made on a company by company basis and will
be available for leases finalised on or after 1 April 2006, where the asset
has not been leased before or has only previously been leased under a long
funding lease. The effect of the election is that lessors should be taxed on
their accounting profit as long as the accounting profit reflects the profits
that would be taxed on a statutory basis under the new regime.
Anti-avoidance
Double Benefit leasing
HMRC will introduce rules which are intended to prevent companies achieving a
double benefit, i.e. both the lessor and the lessee claiming capital
allowances.
The Government is concerned that independent decisions by the lessor and
lessee on whether a lease is a funding lease or not could lead to double
allowances so they have stated that a lessor’s right to claim allowances
should take precedence over the lessee’s right to claim allowances. The
entitlement to claim capital allowances will rest with the superior lessor in
the chain, whether or not they are within the charge to UK tax. In
circumstances where the lessee cannot establish entitlement to capital
allowances, the lessee will receive a deduction for the lease rentals payable.
Lease term
The length of a lease term is essential in determining whether a lease is a
long funding lease or not. HMRC are therefore understandably concerned that
this is an area which may be exploited. The lease term will therefore include
the term of any extension option where it is “reasonably certain” at the lease
term that the option will be exercised.
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