BLM51030 - Right-of-use assets: Right-of-use asset lessees: taxation of right-of-use asset lessees: Long funding leases and the funding lease test

A long funding lease must be both: 

  • a plant or machinery lease (s70K CAA 2001) (see BLM20130)

  • a funding lease (s70J CAA 2001) (see BLM20205) 

A long funding lease must also meet all the following conditions: 

  • it is not a short lease (s70I CAA 2001) (see BLM20510) 

  • it is not an excluded lease of background plant or machinery for a building (s70R CAA 2001) (see BLM21305) 

  • it is not excluded because it is a lease of plant with land and the plant has a low percentage value (s70U CAA 2001) (see BLM21600) 

A lessee who recognises a right-of-use asset must apply these rules in the same way as any other lessee.  The only difference is that such a lessee cannot have a funding lease by virtue of the finance lease test (s70N CAA 2001).  Instead, theycan only have a funding lease by meeting either the lease payments test (s70O CAA 2001) or the useful economic life test (s70P CAA 2001).  

Example 1 

Train Operator Ltd has adopted IFRS 16 and enters into a lease for plant and machinery which meets all the conditions to be a long funding lease bar a consideration of whether it is a finance lease.  The lessee recognises a lease liability of £1,000,000 at inception.  The fair value of the asset is £1,200,000.  Although the lease liability could differ from the present value of the minimum lease payments it would be unusual for that to be the case and therefore it would be expected that the lease entered into by Train Operator Ltd would meet the lease payments test, that is, the present value of the minimum lease payments is equal to or greater than 80% of the fair value of the leased asset. 

Example 2 

Bus Tours Ltd prepares accounts under FRS 102 (2024 amendments) and enters into a lease for plant and machinery which meets all the conditions to be a long funding lease bar a consideration of whether it is a finance lease.  The lease is for an initial period of 7 years with options to extend for a further 3 years and it is reasonably certain that the option to extend will be taken up. The accounting recognises a right-of-use asset which will be depreciated over 10 years.  The expected useful economic life of the asset subject to the lease is 13 years.  Whilst the term of the lease used in the useful economic life test could differ from the accounting recognition of the length of the lease,that would be unusual.  Consequently, it is expected that the lease entered into by Bus Tours Ltd would meet the useful economic life test, because the term of the lease is more than 65% of the remaining useful economic life of the leased asset.