BLM00320 - Introduction: Lease taxation: Leasing and capital allowances

The availability (or not) of capital allowances to a lessor is often crucial to a business in deciding whether to enter into a lease, particularly a finance lease, but also in the case of some operating leases, especially where the lease is used to provide off balance sheet finance.

Prior to FA 2006 any plant or machinery allowances due normally went to the legal owner of the asset (the lessor). The benefits that could arise from capital allowances are described at BLM00700 onwards, but in broad terms their effect is to reduce what amounts to the cost of borrowing. That is the ‘interest element’ of finance lease rentals for an asset costing a particular amount could be less than the interest payable on a loan for the same amount.

This benefit often affected the decision on whether to buy or lease an asset. This distortion of business decisions was addressed in FA 2006 with the introduction of a new regime for taxing long funding leases of plant or machinery. These rules move the right to capital allowances from lessor to lessee, thus removing the benefit previously enjoyed by lessors where the lease is a long funding lease.

In some circumstances, particularly where the asset had a short economic life, lessors actually suffered a disadvantage if they needed to claim capital allowances, see BLM30235.

BLM20000 gives more background on the reasons for introducing the regime for taxing long funding leases of plant or machinery.

Note that if the lessee incurs capital expenditure and there is a purchase option in a lease of plant or machinery the capital allowances may (but may not) go the lessee, see BLM00325 onwards.