lease taxation
The Pre-Budget Report (PBR) on October 9 continued the tradition
of a biennial crop of announcements of new rules in lease taxation,
in the autumn and spring fiscal statements.
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One of these brings a new and apparently final chapter to the
special rules on sale and finance leasebacks. This particular story
started at the time of Chancellor Brown’s first Budget statement in
1997 Rules enacted then, and now consolidated in Sections 222
& 224 Capital Allowances Act 2001 (CAA), restrict the tax
benefits of sale and finance leasebacks of relatively long life
plant.
For capital allowances (CA) purposes, the capital amounts paid
by the lessor/ purchaser and received by the seller/ lessee are
capped at the tax written down value reflecting the capital
allowances claimed previously by the seller.
Later these rules were exploited by profitable seller/ lessees
passing title to lessor/ purchasers in a tax loss position, and
gaining a tax advantage from the capping of the sale proceeds. This
was the reverse of the original perceived abuse, where a
refinancing customer would typically be in tax loss, and selling to
a profitable commercial lessor. So in the 2004 Finance Act a new
provision (Section 228B CAA as amended) limited the seller/
lessee’s relief for the lease rental payments and brought the tax
treatment of the transactions more into line with their commercial
substance.
Now HM Revenue & Customs (HMRC) has become aware of
arrangements to sidestep the effect of Section 228B by using a
lessee company which is non-resident in the UK and therefore
impervious to the rental relief restriction. This could involve
either a lessee in the same corporate group as the UK seller of the
plant, or a case where the seller/ lessee becomes non-UK resident
after the sale.
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By GlobalDataHMRC’s solution this time is to scrap the bulk of the existing
tax legislation on sale and finance leasebacks, and replace it with
a heavier restriction. The leases involved in all transactions of
this kind will now be treated in the same way as long funding
leases (LFLs) as defined in Schedule 9 of the 2006 Finance Act,
irrespective of their duration. So lessor/ purchasers will be
ineligible for CAs.
This change will be enacted in next year’s Finance Bill and
backdated to apply to transactions from the PBR date. As in the
original legislation, an exception will be made for the case where
sale and leaseback is merely the mechanism for the lessor to assume
title to new or nearly new equipment, as opposed to a refinancing
facility for used plant.
An apparently more aggressive tax abuse, itself building on the
LFL rules, is targeted by another PBR announcement. It seems that
in some cases taxpayers have acquired plant and machinery as
trading stock, thus writing off the cost for tax in the year of
purchase, and leasing it out to other parties under LFL
transactions. Part of the rental income is then tax-free, under the
standard LFL rules for the case where the lessor does not claim
CAs.
It does not seem that companies with an established leasing
business could have taken advantage of this device, since their
portfolios are treated as capital assets and not trading stock.
Indeed HMRC states a belief that it could successfully challenge
any party’s use of the scheme as the law stands; but since it is
not certain that the courts would agree, remedial legislation will
be made effective from the PBR date.
This will take a two-pronged approach. One provision will
dis-apply the LFL rules for lease rental income (Section 502B – G
of the CAA as amended) where the lessor is able to claim a trading
deduction for the asset cost. Another, potentially much more far
reaching, will have the same effect wherever the LFL rules are used
to generate tax losses in the absence of commercial
losses.
Finally, there will be a further tweak to the rules on the sale
of leasing companies. During the heyday of tax-driven leasing it
was common for mature leasing portfolios, having been packaged in
separate subsidiary companies, to be sold off by mainstream lessors
to purchasers in a tax loss position, after the annual writing down
allowances started to diminish so that the portfolio moved out of
tax loss to generate taxable profit. Rather late in that era, the
authorities decided that this was an unacceptable avoidance
technique and blocked it through Schedule 10 of the 2006 Finance
Act. This cancels the potential net tax saving by imposing a tax
charge on the seller of the leasing company, and giving a
symmetrical relief to the purchaser – who, if in tax loss, will not
be able to make use of it.
It has now been found that due to a drafting error this
legislation does not give the intended relief to one category of
purchaser – a single company acquiring a leasing subsidiary from
seller companies in a limited partnership. An appropriate amendment
will be made fully retrospective.
