Budget Notes

BN20 LEASED PLANT OR MACHINERY: ANTI-AVOIDANCE

Who is likely to be affected?

1. Businesses leasing plant or machinery.

General description of the measure

2. This measure will counter avoidance by businesses who lease in and lease out the same plant or machinery to exploit differences in the way in which lease rentals paid and received are taxed in order to generate a tax loss where there is no commercial loss.

3. The measure will also counter avoidance involving leases of plant or machinery which are granted in return for a capital payment, often described as a premium, and similar arrangements, in circumstances where the capital payment currently escapes taxation.

4. Minor changes will be made to the leased plant or machinery antiavoidance measure which was announced on 9 October 2007. The changes will clarify the operation of the rules in a sale and finance leaseback and introduce new rules to ensure that lease and finance leaseback arrangements are treated in a similar way.

Operative date

5. The measure will generally have effect for transactions entered into on or after 13 December 2007. Some aspects of the measure, as explained below, will have effect on and after 12 March 2008.

Current law and proposed revisions

Mismatched lease chains

6. A business may act as an intermediate lessor, leasing in plant or machinery under one lease and leasing it out under another. Such leases may be broadly similar but be designed to exploit differences in the way in which leases are taxed. The avoidance involves arrangements which allow the business, as lessee, to deduct all the lease rentals payable under the lease but, as lessor, to be taxed on only a small portion of the rentals receivable. This creates a tax loss where there is no commercial loss.

7. Legislation to address this will be included in Finance Bill 2008. This will ensure that rentals received by intermediate lessors will be taxed on the same basis as rentals paid and that intermediate lessors are taxed on their commercial profits.

Lease premiums

8. Businesses have been granting leases on plant or machinery for a premium plus a small amount of annual rentals. The premium, which is commercially broadly equivalent to the sale of the asset, escapes tax because it is not brought in as a disposal receipt for capital allowances purposes and little or no tax would be payable under the chargeable gains regime.

9. This measure will ensure that, with the exceptions described below, payments will be taxed as income of the lessor where they are not otherwise taxable as income or as a capital allowances disposal receipt, and which either:

•    are made by or on behalf of the lessee to the lessor or to another person on the lessor's behalf and are paid in connection with the grant of a lease or in other specified circumstances; or

•    reduce the rentals otherwise payable under the lease.

10. Where payments are made on or before 11 March 2008, the new rules will have effect only for payments made in respect of leases of plant or machinery that are not leased with other assets.

11. Where payments are made on or after 12 March 2008 the rules will also have effect for plant or machinery (other than fixtures) leased with other assets but only to the extent that:

•    it is reasonable to attribute the capital payment to that plant or machinery; and

•    if the payment were income, it would not be taxable under Schedule A.

12. These rules are designed to ensure that payments associated with typical real property leases will not be affected by the measure.

13. In addition, the rules will not have effect for:

•    payments made in connection with long funding leases where the lessor is not entitled to claim capital allowances because of the effect of section 34 of the Capital Allowances Act 2001 (CAA);

•    contributions made by the lessee that reduce the lessor's qualifying expenditure for capital allowances purposes;

•    indemnity payments made by the lessee to the lessor to compensate the lessor for a loss arising as a result of damage to, or damage caused by, the leased asset.

14. The measure will also counter attempts to reduce or avoid a disposal value for capital allowances and chargeable gains purposes on the granting of a long funding finance lease.

15. In each case, the disposal value is based on the value of the leased asset as shown in the lessor's balance sheet. This value can be reduced where rentals are payable on the day the lease is entered into or where the leased asset is linked to a corresponding liability, requiring the asset and liability to be netted off.

16. This measure will ensure that the disposal value is not reduced where rentals are receivable on the day on which the lease is granted. In addition, where the lease is granted on or after 12 March 2008, the measure will ensure that the disposal value is not reduced by matching the leased asset with liabilities in a way that means the lessor's net investment in the lease is reduced or eliminated. From that date, the disposal value will be determined on the basis that the lessor has no liabilities.

Sale and finance leaseback

17. The draft legislation published on 9 October 2007 provided that, in the case of a sale and finance leaseback, the finance lease should not be treated as a short lease. In most cases, this means it will be treated as a long funding lease. There may be more than one finance lease in the leaseback arrangements and, with effect on and after 12 March 2008, it will be made clear that none of these finance leases should be treated as a short lease, so no lessor in the leaseback arrangements is entitled to claim capital allowances.

Lease and finance leaseback

18. The draft legislation published on 9 October 2007 made no special provision for the taxation of the finance lease (or leases) in the leaseback part of a lease and finance leaseback. With effect on and after 12 March 2008, it will be made clear that each finance lease in the leaseback should not be treated as a short lease, so no lessor in the leaseback arrangements is entitled to claim capital allowances.

19. Following the introduction of this measure, section 228B of CAA, which restricts the amount that a lessee may deduct in a lease and finance leaseback, only has effect in exceptional circumstances. Nevertheless, with effect from 12 March 2008, an amendment will be made that will ensure the rules have effect where the leaseback is to a person connected to the head lessor.

Further advice

20. Draft legislation, covering mismatched lease chains and lease premiums, was published on 13 December 2007.

21. If you have any questions about this change, please contact Paul Lane on 020 7147 2637 (email: paul.lane@hmrc.gsi.gov.uk). Information about Budget measures is available on the HM Revenue & Customs website at www.hmrc.gov.uk