BLM25125 - Defining long funding leases: miscellaneous definitions: term of a lease: 'reasonably certain': example 3 - fiscal neutrality

Isobel leases machines that cost £4,000 each and typically have a life of 5 to 10 years. Lease rentals are £1000 a year. Minimum lease period is 5 years. At the 5 year point, each lessee can either

• carry on renting the machine for £10 a year, or
• terminate the lease and require the lessor to sell the machine and repay an amount equivalent to 99% of the net sale proceeds by way of a rebate of rentals.

On the facts, it is not clear which option would be beneficial and so the lessee is not reasonably certain to exercise the option to extend the lease term.

Note, however, that there may be other factors which alter this outcome. That is the fact that neither the lessor nor the lessee is financially penalised if an option to extend the lease was not exercised is not, by itself, conclusive proof that the option is not reasonably certain to be exercised. There may be other factors that point to a different conclusion (see example 4 at BLM25130).

Having said that, fiscal neutrality is, of course, a pointer to the fact that the lessee is not reasonably certain to exercise the option. But, in material cases, you should consider looking at all the facts before deciding whether to accept or challenge a view on whether a lessee is reasonably certain to exercise an option.