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March 25, 2011updated 25 Jan 2022 10:31am

New UK legislation explained

The first will seek to preserve the current tax position of companies affected by the International Accounting Standards Boards (IASB) proposed changes to lease accounting.

By Judy Harrison

Norton Rose’s Judy Harrison and Layla Kattan explain how the Finance Bill 2011 affects leasing.


Finance Bill 2011 will contain two sets of draft legislation aimed at the leasing industry. The first will seek to preserve the current tax position of companies affected by the International Accounting Standards Board’s (IASB) proposed changes to lease accounting.

The second is aimed at a tax avoidance scheme involving long funding finance leases and residual value guarantees.

The 2011 Budget may contain further announcements which affect leasing companies, and if so these will be covered in May’s edition of Leasing Life.


Lease accounting

Finance Bill 2011 will contain legislation which provides that, in calculating the amount of a person’s taxable profits, one must ignore any changes to a lease accounting standard on or after 1 January 2011 other than a change which permits, or requires, a person to account for a lease in a manner equal to that provided for by the International Financial Reporting Standard for small- and medium-sized entities.

The reason such change is needed is that the tax treatment of lease income depends on the accounting treatment. For example, there are several provisions of tax legislation where the Pull quotetaxation of a lease (either as lessor or as lessee) depends upon whether it is a finance lease or an operating lease.

This change has been triggered by the announcement of proposals by IASB to change the way leases are accounted for, although the draft legislation encompasses all future changes to lease accounting and not just those currently proposed by the IASB.

The IASB is proposing to remove the distinction between finance leases and operating leases from the perspective of a lessee. Lessors will still be required to classify leases and adopt different accounting practices depending upon the classification.

The classification will be based on similar criteria to the finance lease/operating lease distinction in current accounting standards.

Where a lessor has retained significant risks in an asset, it will be required to adopt the performance obligation approach. For other leases, the lessor will be required to adopt the derecognition approach.

The draft legislation aims to ensure that businesses that account for lease transactions continue to be taxed in the same way as they are at present following a change in the accounting standards. In calculating accounting profits, companies will need to use whatever accounting standard is in force at the time.

For tax purposes, companies will need to compute their accounting profits under the lease accounting standards in force on 1 January 2011. The need to calculate a second set of profits will impose a cost on those businesses that lease assets either as lessor or as lessee.

Such cost will presumably increase over time as it becomes more difficult to find advisers who are suitably qualified to advise on the accounting standards in force on 1 January 2011.

Some readers may recall that, in the context of securitisation, a similar approach was adopted on a temporary basis in calculating taxable profits.

Nothing in the draft legislation or guidance indicates that the UK government intends these changes to be temporary although we understand that this is intended to be no more than a short- to medium-term solution.

However, it is to be hoped that in the not too distant future a more practicable long-term solution is found.


Long funding leases and residual value guarantees

Legislation will be included in Finance Bill 2011 to combat a scheme whereby a long-funding finance lease would be granted and the lessee group provide a residual value guarantee to the lessor.

On expiry or termination of the lease, the residual value guarantor would make a payment to the lessor. The benefit of this scheme was that tax relief was available for the residual value payment more than once – the guarantor would get relief for making the payment and the lessee would have increased capital allowances and a lower disposal value as a result.

The new rules apply where the amount payable under a residual value guarantee attracts tax relief (other than where the lessee is entitled to a greater amount of capital allowances or to bring a lower disposal value into account).

They operate to: decrease the amount of qualifying expenditure available to lessees under long funding finance leases by the value of the residual value guarantee for any arrangements entered into on or after 9 March 2011; and to increase the amount of the disposal value to be brought into account by the lessee on expiry or termination of the long funding lease by the value of the residual value guarantee where any payment is made on or after 9 March.

While these rules have been introduced to combat a particular tax avoidance scheme, they potentially have wide application. They will need to be considered whenever residual value support is obtained for a long-funding finance lease.

Judy Harrison is a senior associate and Layla Kattan an associate at law firm Norton Rose

Photo of Norton Rose’s Judy Harrison (left) and Layla Kattan

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