BLM62230 - Plant and machinery leasing - Anti-avoidance: Long funding lease rules: Disposal values: Lessor disposal value reduced by advance payments made
Leases entered into on or after 1 April 2006
As well as the Lease Premium avoidance described in BLM62220 similar schemes were used that, instead of a premium, relied on an advance or up front payment of rentals. That payment was claimed to have also the effect of reducing the net investment in the lease that formed the disposal value under section 61(2)(5A) CAA 2001.
If a lease was granted, and the majority of the lease rentals were then paid on the day the lease was entered into, the net investment in the lease - as calculated at the end of the first day - would then only reflect the remaining amount of the lease rentals outstanding.
As with the premium cases, because accounts are drawn up at the end of a business day, the net investment in the lease shown on the day that the lease commenced would not include a day one upfront payment of rentals. That initial payment would therefore have the effect of artificially lowering the disposal value of the lessor.
Arrangements were undertaken which involved a large advance lease rental payment being made on the date the lease was entered into, reducing the net investment in the lease at then end of the day. This resulted in an artificially low disposal value to be brought in on the grant of a long funding lease under item 5A of the Table at section 61(2) CAA 2001 and created unintended taxpayer benefits.
Example
Kristy Limited owns plant or machinery with a market value of £25m but it has a tax written down value of only £5m. Kristy Limited grants a 15 year long funding finance lease with an initial rent payable on the day the lease is entered into of £24m and subsequent rents of £125,000 per annum. The disposal value for Kristy Limited is based on the net investment in the lease if accounts were drawn up on the day the lease is first recognised, which would only be the net present value of the rents of £125,000 a year as this is what is outstanding at the end of the day - £1.5m in this case. Had the £24m been paid the day after the lease was entered into, then the £24m would also have been included in the calculation for the net investment in the lease and therefore would be within Kristy Limited’s section 61 disposal value.
Other arrangements seen, included lease and finance leasebacks with an advance payment made by the lessee, under the head lease, on the day the head lease was granted. The net investment in the lease was recorded in the lessor’s accounts at the end of the day, after the advance payment has been made, at significantly less than the market value. This resulted in a low disposal value for the plant or machinery. However, the lessee under the leaseback was entitled to claim capital allowances based on the full market value of the asset. The difference between these two amounts therefore went untaxed.
Leases entered into on or after 13 December 2007
These arrangements were initially addressed by the introduction of section 61(6) CAA 2001. This applied section 61(7) CAA 2001, which sought to ensure that the net investment in the lease was adjusted to treat all lease payments made on or before the relevant date, as made the day after that date. However the amendments were not wholly effective, in particular it failed to address the premium issue described at BLM62220.
Leases entered into on or after 13 November 2008.
Section 61(6)-(9) CAA 2001 were repealed for leases whose inception was on or after 13 November 2008 when item 5A of the table at section 61(2) CAA 2001 was rewritten to include the ‘qualifying lease payments’ as determined by section 61(5A) CAA 2001 which specifically included initial payments.