Section 27 Schedule 5: Leased Assets
Summary
1.Section 27 and Schedule 5 introduce legislation to tackle two avoidance schemes involving the leasing of plant or machinery in relation to which HM Revenue & Customs (HMRC) have received disclosures.
2.The first scheme involves arrangements intended to create a company that is taxed on very little income from the leasing of an asset, but which is potentially able to claim capital allowances on the full cost of the asset, creating tax losses where there is a commercial profit. The first scheme may, alternatively or additionally, rely on obtaining a deduction for a rebate of rentals to generate a tax loss where there is a commercial profit.
3.The second scheme involves arrangements where a lessor that has claimed capital allowances in the initial loss-making phase of a lease of plant or machinery avoids tax on the income that arises once the lease moves into its tax-profitable phase. The intended effect is to turn a tax-timing advantage into a permanent loss of tax on a transaction that is commercially profitable.
Details of the Schedule
4.Paragraph 1 of the Schedule is concerned with the restriction of qualifying expenditure in case of certain leased assets
5.Paragraph 1(1) inserts new section 228MA (Restriction of qualifying expenditure) into the Capital Allowances Act 2001 (CAA).
6.Section 228MA of CAA is the main new substantive section. It limits the amount of capital expenditure that is treated as qualifying expenditure and so limits the amount on which a lessor may claim capital allowances.
7.Subsection (1) provides that the section applies where there are arrangements under which plant or machinery is to be leased and there are arrangements under which the value of the asset to the lessor (“V”) is reduced. Subsection (1) will apply when the lessor is treated as incurring capital expenditure under section 67 of CAA (hire purchase etc) or under section 70A of CAA (long funding leases).
8.Subsection (2) restricts the amount of the lessor’s qualifying expenditure to “V”.
9.Subsection (3) defines “V” as the aggregate of the amount of the present value of the lessor’s income from the asset and the amount of the present value of the residual value of the asset after any rental rebate.
10.Subsection (4) defines the lessor’s income from the asset for the purposes of determining “V”, to include all amounts that it is reasonable to expect the lessor will receive in connection with the lease and which will be taxed as income (this includes amounts treated as income, for example under section 890 of the Corporation Tax Act (CTA) 2010). The subsection also defines the residual value as the market value (which is defined in section 577 of CAA) of the lessor’s interest in the asset immediately after the termination of the lease. The reference to “lessor’s interest” caters for the situation where the lessor is the beneficiary of a contract under section 67 of CAA or a lessee under a long funding lease.
11.Subsection (5) excludes from the lessor’s income amounts which have been brought into account as disposal receipts for capital allowances purposes, charges made by the lessor for services supplied in connection with the leased asset and qualifying UK and foreign tax paid by the lessor.
12.Subsection (6) caters for the possibility that the lessor incurs the capital expenditure in instalments and ensures it operates in a cumulative fashion.
13.Subsection (7) introduces new sections 228MB and 228MC of CAA.
14.Subsection (8) defines a “lease” for the purposes of this section and new sections 228MB and 228MC.
15.New section 228MB of CAA explains how the present value is to be calculated. In the case of both the amounts receivable in connection with the lease and the residual value at the end of the lease term the present value is based on the interest rate implicit in the lease, but it provides for an alternative (London interbank offered rate plus 1 per cent) if the rate cannot otherwise be established.
16.New section 228MC of CAA defines rental rebate for the purpose of new section 228MA. The definition is largely based on the definition in section 70YH of CAA.
17.Paragraph 2 of the Schedule is concerned with the restriction of deduction for rental rebate.
18.Paragraph 2(1) inserts new section 55B into the Income Tax (Trading and Other Income) Act 2005 (ITTOIA).
19.New section 55B of ITTOIA applies for the purpose of income tax and operates in essentially the same way as the new rules for corporation tax. Section 55B is drafted in materially identical terms to new section 60A of CTA 2009 (inserted by paragraph 2(2) of the Schedule). HM Revenue & Customs anticipates that the new rules are more likely to apply to companies and so the detailed explanatory notes are provided for new section 60A of CTA 2009.
20.Paragraph 2(2) of the Schedule inserts new section 60A (rental rebates) into CTA 2009.
21.New section 60A of CTA 2009 restricts the amount of deduction allowed for a rebate of rentals.
22.Subsection (1) limits the deduction to the amount of the lessor’s income from the lease, which is defined in subsection (4), excluding the finance charge element of finance lease rentals.
23.Subsections (2) and (3) explain what is meant by a rental rebate. The definition is largely based on the definition in section 70YH of CAA.
24.Subsection (4) defines the lessor’s income from the lease to include all amounts that it is reasonable to expect the lessor will receive in connection with the lease and which will be taxed as income (this includes amounts treated as income, for example under section 890 of CTA 2010 but it excludes any amount brought in as a disposal receipt. The subsection also defines the finance charge element of the lease rentals which is excluded from income for the purpose of this section.
25.Subsection (5) provides that where there has been a transfer to which section 948 of CTA 2010 applies, or where an election has been made under section 266 of CAA, new section 60A applies as if the successor had done everything done by the predecessor.
26.Subsection (6) provides that all or part of the amount of a rental rebate that has been disallowed may be treated as an allowable loss for chargeable gains purposes. The amount which may be treated that way is the lower of the amount which has been disallowed and the amount by which the rental rebate exceeds the capital expenditure incurred by the lessor.
27.Paragraph 3 of the Schedule concerns arrangements reducing the disposal value of an asset.
28.Paragraph 3(1) inserts new section 64A (leased assets: arrangements reducing disposal value of asset) into CAA.
29.New section 64A provides that arrangements which reduce the value of leased plant or machinery are to be ignored for the purpose of establishing items 1, 2 and 7 in the table in section 61(2) of CAA.
30.Subsection (1) provides that the section applies only where there are arrangements that have the effect of reducing the disposal value insofar as it is attributable to rentals payable under the lease.
31.Subsection (2) ensures that arrangements that reduce the disposal value are not ignored where the arrangements comprise the transfer of an income steam, the value of which is taxed as income under section 809AZA of the Income Tax Act 2007 or section 752 of CAA 2010.
Background Note
32.This legislation addresses two types of avoidance relating to the taxation of leasing of plant or machinery as disclosed to HMRC as briefly described in the summary above.
33.For the first scheme the avoidance is countered by, in broad terms, limiting the amount on which capital allowances may be claimed to the present value of the amounts that it is reasonable to expect will be brought into account as income in connection with the lease. This includes rents and, for example, amounts treated as income under section 785B of ICTA, but excludes any capital allowances disposal receipts plus the present value of the residual value at the end of the lease less any amount of rental rebate.
34.Where the avoidance in the first scheme is centred on or includes the amount of deduction claimed for rental rebate the legislation counters this. In broad terms, the effect of the rules is that the amount of a rental rebate which may be claimed as a deduction in computing profits is limited to the amount receivable in connection with the lease that has been brought into account in computing the lessor’s income. In calculating this amount, however, the finance charge element of rentals paid under a finance lease is excluded, as are any elements that represent charges for service or tax (section 60A(1) and (4) of CTA 2009).
35.For the second scheme, the legislation addresses the avoidance by ensuring that the disposal value for capital allowance purposes at the time that the lessor disposes of the leased assets, or otherwise ceases to be within the charge to tax in respect of that activity, is computed as if the arrangements had not been entered into.
