October’s release of the pre-Budget report has brought more
changes to taxation rules that will impact on lessees and
lessors
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The pre-Budget report (PBR) on October 9 continued the tradition
of announcing a biennial crop of new rules in lease
taxation.
One of these represents the final chapter in the special rules
on sale and finance leasebacks.This story started in 1997, at the
time of the then Chancellor Brown’s first Budget statement. Rules
enacted then, and now consolidated in sections 222 and 224 of the
Capital Allowances Act 2001 (CAA), restrict the tax benefits of
sale and finance leasebacks of relatively long life
plant.
In effect what they say is that if the lessee, prior to the sale
of its asset, claimed, for instance, a total of £40 in capital
allowances on a piece of equipment worth £100, then the
acquirer/lessor can only claim capital allowances on a figure of
£60 – i.e. £100 minus the already claimed £40. “As a result the
leases involved in all transactions of this kind will now be
treated in the same way as long funding leases (LFLs).”
Later these rules were exploited by profitable sellers/lessees
passing title to lessors/purchasers in a tax loss position, and
gaining a tax advantage from the capping of the sale proceeds.This
was the reverse of the original perceived abuse, where a
refinancing customer would typically be in tax loss and selling to
a profitable commercial lessor.
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By GlobalDataLimited relief
So in the 2004 Finance Act a new provision (section 228B CAA as
amended) limited the seller/lessee’s relief for the lease rental
payments and brought the tax treatment of the transactions more
into line with their commercial position.
Lessees sought to side step section 228B by using a lessee
company which is non-resident in the UK and therefore impervious to
the rental relief restriction. This could involve either a lessee
in the same corporate group as the UK seller of the plant, or a
seller/lessee who becomes non-UK resident after the sale.
Again HM Revenue & Customs (HMRC) has intervened, and in its
pre-Budget report last month it decided to scrap the bulk of the
existing tax legislation on sale and finance leasebacks, and
replace it with a heavier restriction.As a result the leases
involved in all transactions of this kind will now be treated in
the same way as long funding leases (LFLs) as defined in Schedule 9
of the 2006 Finance Act, irrespective of their duration.Therefore
lessors/purchasers will be ineligible for CAs.
This change will be enacted in next year’s Finance Bill and
backdated to apply to transactions from the PBR date.As in the
original legislation, an exception will be made in cases where sale
and leaseback is merely the mechanism for the lessor to assume
title to new or nearly new equipment, as opposed to a refinancing
facility for used plant.
Tax abuses
An apparently more aggressive tax abuse, itself building on the
LFL rules, is targeted by another PBR announcement. It appears that
in some cases taxpayers have acquired plant and machinery as
trading stock (as distinct from capital assets), thus writing off
the cost for tax in the year of purchase, and leasing it out to
other parties under LFL transactions. Part of the rental income is
then tax-free under standard LFL rules, when lessors do not claim
capital allowances. Companies with an established leasing business
are unlikely to have taken advantage of this device since their
portfolios are treated as capital assets and not trading
stock.
HMRC believes it could successfully challenge any party’s use of
the scheme as the law stands.However, since it is not certain that
the courts would agree, remedial legislation will be made effective
from the PBR date.
This will take a two-pronged approach. One provision will
dis-apply the LFL rules for lease rental income (Section 502B – G
of the CAA as amended) where the lessor is able to claim a trading
deduction for the asset cost.Another provision, one that is
potentially much more far reaching,will have the same effect
wherever the LFL rules are used to generate tax losses in the
absence of commercial losses.
Sale of leasing companies
Finally, there will be a further tweak to the rules on the sale
of leasing companies. During the heyday of tax-driven leasing it
was common for mature leasing portfolios – having been packaged in
separate subsidiary companies, to be sold off by mainstream lessors
to purchasers in a tax loss position, after the annual writing down
allowances started to diminish – so that the portfolio moved out of
tax loss to generate taxable profit. “Part of the rental income is
then tax-free under standard LFL rules, when lessors do not claim
capital allowances.”
Rather late in that era the authorities decided that this was an
unacceptable avoidance technique and blocked it through Schedule 10
of the 2006 Finance Act.This cancels the potential net tax saving
by imposing a tax charge on the seller of the leasing company, and
giving a symmetrical relief to the purchaser – who, if in tax loss,
will not be able to make use of it.
It has now been found that due to a drafting error this
legislation does not give the intended relief to one category of
purchaser – a single company acquiring a leasing subsidiary from
seller companies in a limited partnership. An appropriate amendment
will be made fully retrospective.
