In the following brief article I highlight the key accounting and tax points that need to be considered before implementing these transactions. S&LB on property and related assets are extremely complex and could not be covered within this short article.
UK GAAP, SSAP 21 & FRS 5 provide guidance. The risk and rewards of ownership of the asset need to be considered to determine whether the asset has been sold or just pledged as security for a loan. This will determine if the transaction is accounted as a finance lease or as a genuine sale, thereby determining the need to recognise the profit or loss on sale.
If a finance lease, any apparent profit or loss should amortised over the shorter of the lease term and the useful life of the asset. If the leaseback is an operating lease, any profit and loss:
• Should be recognised immediately if at fair value;
• Should be recognised immediately if the sale price is below fair value, except if the apparent loss is compensated by future rentals at below market price it should be amortised over the remainder of the lease term
Over fair value should be amortised over the shorter of the remainder of the lease term and the period to the next rent review Treatment under IAS 17 of the IFRSs is very similar to UK GAAP, although leases are more likely to be finance in nature given the prescriptive tests and there is no 90 percent minimum lease payment rule.
HMRC has been tightening the tax regime for S&LB transactions over a number of years. The latest set of changes were introduced in the Finance Act 2008.
The FA 2008 now treats the vast majority of S&LB transactions as a sale and “long funding” lease back for tax purposes. This means capital allowances are generally retained by the lessee and the lessor is taxed on its accounting profit.
There is one helpful dispensation, often called the “four month rule”. This dispensation allows the parties to elect out of the long funding rules on the S&LB of new or nearly new plant assets within the first four months. This means right to capital allowances can still be transferred to the lessor.
From a VAT perspective, S&LB transactions have been used by partially exempt organisations to spread the VAT cost over the life of the lease. These have often involved in-house leasing companies.
HMRC has introduced anti-avoidance legislation which requires disclosure of arrangements to be made if the parties involved in the transaction are connected. Failure to adhere to these rules could lead to significant penalties. Although these changes do not ordinarily impact on commercial arms length arrangements, they can impact on arrangements between unconnected parties in cases where the lessee directly or indirectly funds the purchase of the leased goods.
In conclusion S&LB is and will continue to be an important funding method, although the accounting and tax aspects need careful consideration to avoid costly pitfalls.
The author is the head of Leasing & Asset Finance at Grant Thornton