OT21745 - Energy Profits Levy: Meaning of leasing expenditure

EPLA22\S4

There are two conditions that must be met for expenditure to be leasing expenditure. These are:

  1. Expenditure must represent payment in return for a mobile production or storage asset being made available, and it must be under a lease whose term is at least 5 years, and

  2. On the date the expenditure is incurred, no relevant tax relief can have been obtained in respect of the acquisition of the asset.

For an asset to be mobile, it does not necessarily need to move on a regular basis, but it must be capable of moving to be used in another location. This could mean the asset is used in the same place for many years at a time, and this would not necessarily prevent it from meeting the mobile condition as long as it could be moved to be used at a different site.

A ‘mobile production or storage asset’ is defined as one whose main function is the production or storage of oil. It is a question of fact whether the main function of an asset is the production or storage of oil. The asset’s main function will usually relate to the use the asset is put to under the lease in question, rather than the purpose for which it was designed. It will typically include FPSOs used for production and storage. Leasing of other assets, such as tankers or accommodation platforms, is not leasing expenditure, because the main purpose of these assets is transportation or accommodation, rather than production or storage.

In certain scenarios, including where a lease is sold, or is terminated early, a lessee may receive from the lessor, or another party, a payment in respect of the lease. This could include a refund of leasing expenditure, compensation in respect of the lease, or disposal proceeds on sale of the lease.

Where amounts are received, the amount in respect of which allowance is generated could exceed the true economic value of the investment.

To deal with this kind of situation, EPLA22\S4(2) restricts leasing expenditure to that which exceeds the total amount received by the company and its associated companies in respect of any qualifying leases, requiring any leasing expenditure to be set against any amounts received in the year or in any previous year, before any further allowance can be generated. But it excludes:

  • amounts received from the lessee where the parties to the lease are associated companies, or
  • amounts previously set against expenditure which would otherwise have counted as leasing expenditure.

For example, if leasing expenditure totalled £1,000 in APE23, and allowance is generated on that amount, but £200 is subsequently refunded in APE24, then the amount on which the allowance was generated would exceed the true economic value of the investment of £800 and thus the £1,000 previously treated as leasing expenditure will be restricted by EPLA22\S4(2).

When an asset subject to a lease is sub-let, the sub-lessee may generate the allowance in respect of lease expenditure they incur, subject to all other conditions being met. During the period of the sub-lease, the sublessor will not be able to generate allowances in respect of that asset, as the asset will not be being used for the purposes of the sub-lessor’s ring fence trade. However, the sub-lessor may generate allowance during the period when the asset is not sub-let, provided that the asset is being used for the ring fence trade and satisfies all other conditions. This could lead to excessive allowance being generated if the sublease leasing expenditure is higher than the head lease. This could be because payments under the head lease were front-loaded, or there were ‘balloon payments’ at the end of the head lease, so that allowance was generated on the excess amounts before or after the lease was sub-let. To prevent excessive allowance being generated, if a sub-lease is entered into or modified on or after 26 May 2022, then expenditure is not leasing expenditure if it exceeds the total amount of leasing expenditure incurred in relation to the head lease during the term of the sublease (EPLA22\S4(4)). This caps the amount of leasing expenditure under a sub-lease that can generate allowance at the amount of leasing expenditure paid under the head lease during the same period.

EPLA22\S4(5) provides a non-exhaustive list of circumstances when expenditure is not treated for the purposes of this section as representing payment in return for an asset being made available (and, accordingly, not “leasing expenditure” for the purposes of EPLA22\S4). These include:

  • any charge for the provision of any staff or for any services,
  • any amount payable which is, or represents, a profit or premium on the cost of the asset being made available which is paid by the company to an associated company,

  • any amount which, in accordance with GAAP, falls (or would fall) to be shown in the company’s accounts as a finance charge in respect of a lease, or

  • any amount that can be attributed to finance costs by reference to the interest rate implicit in the lease (which is to be taken to be the interest rate that would apply to the lease in accordance with normal commercial criteria, including, in particular, GAAP (if applicable)).

EPLA22\S4(7) provides that a just and reasonable apportionment is required if expenditure incurred only partly represents payment in return for a mobile production or storage asset.