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The Government have introduced changes to the way certain leases of plant or machinery and films are taxed. The changes have effect from 13 November 2008, the date of the release of three technical notes relating to leasing ('Plant and machinery leasing: anti-avoidance'; 'Sale of lessor companies - intermediate lessors' and 'Leasing avoidance by film partnerships').

The first set of measures tackles perceived avoidance using the rules relating to how leases of plant or machinery are taxed. The changes may affect any company entering into a lease of plant or machinery whether or not for a commercial purpose.

The second set of measures are in response to perceived avoidance relating to the "Sale of Lessor" rules which can apply upon the change in ownership of a company which is a lessor of plant or machinery. The changes are likely to affect those who seek to avoid a charge arising under the Sale of Lessor rules, whether or not the underlying transaction is commercially motivated.

Finally, the Government have introduced changes to counter perceived avoidance relating to film leasing. These changes are likely to affect mainly those seeking to shelter rental income arising from leases of films.

Changes to plant or machinery leasing rules
Changes to the Sale of Lessor rules
Changes to the Film leasing rules

Changes to plant or machinery leasing rules

The changes impact certain arrangements whereby a company which owned plant or machinery could refinance these assets and obtain additional capital allowances in addition to their original expenditure on the plant or machinery.

The first change inserts a market value "floor" or minimum on the capital allowance disposal value taken to the capital allowance pool on the grant of a long funding finance lease. This seeks to counter avoidance arrangements whereby the disposal value to be brought into account before these changes on the occasion of a grant of a long funding finance lease was negligible. In a typical arrangement, the long funding finance lessor would then lease back the plant or machinery under a long funding operating lease to obtain an entitlement to capital allowances under the lease back on the market value of the plant or machinery.

Now that there is a disposal value of at least a market value whenever a long funding lease is granted the Technical note also brings changes to ensure that where there is an initial payment under a lease it is not deemed taxable under s785B ICTA 1988 (which taxes capital sums due under leases as if they were income attributable to the lease).

The second change tackles arrangements whereby owners of plant or machinery with a market value in excess of original cost could sell (or lease) and leaseback the plant or machinery and achieve additional capital allowances on the excess of market value above original cost. The changes limit the amount of qualifying expenditure for capital allowances on the leaseback to the disposal proceeds brought into the capital allowance pool on the outward sale (or lease) or, if there is no such disposal value the lower of market value and original cost to the seller (or head lessor) group.

A further aspect of these changes is that they remove the choice that a long funding lessee generally has as to whether to claim capital allowances or instead claim rental deductions under the lease, if the lease is a leaseback arrangement.

There are also changes to the availability of first year allowances or annual investment allowances in certain arrangements involving the leasing of plant or machinery. A lessee under a long funding leaseback or a hire purchase contract which would confer capital allowances on the lessee is denied a first year allowance or annual investment allowance if he would otherwise have been entitled to one.

Finally, changes have been made to the rules governing the termination of a long funding lease. If a lessee has been entitled to a deemed addition for capital allowance purposes under the long funding lease rules then upon the termination of the lease a comparison should be made between the amount of that addition and the amount of net expenditure under the lease, with the difference being brought into account as a disposal value.

Changes to the Sale of Lessor rules

Anti-avoidance legislation introduced in Schedule 10 Finance Act 2006 removed the tax advantage arising from the sale of certain lessor companies. Such companies typically show a period of tax losses, during which the tax allowances arising from the plant and machinery in question exceed taxable rentals, followed by a period of predictable taxable profits as the tax allowances become insignificant although the rentals continue as before. By selling the company to a loss-making group before the period of taxable profits begins, the tax liabilities otherwise arising during the tax profitable period could be avoided. The Finance Act 2006 changes removed this opportunity by imposing a deemed tax charge on the company being disposed of equivalent to the excess tax allowances received prior to the sale: although there is a mirror tax deduction to the same company following the purchase such deduction cannot be offset against the deemed income. There is no commercial purposes test in the Sale of Lessor rules and we are aware that the charge has potentially applied to commercially motivated disposals of leasing businesses.

HMRC is currently undertaking a consultation exercise to identify whether certain relieving provisions could be introduced to Schedule 10.

In the meantime, the changes announced on 13 November seek to counter arrangements to avoid Schedule 10 whereby a leasing company with an inherent Schedule 10 charge sold plant or machinery assets subject to leases and leased the assets back under a long funding lease. The long funding leaseback means that the leasing company continues to be entitled to claim capital allowances in respect of the plant or machinery. One of the requirements for the Schedule 10 charge to trigger is that at least half of the accounting value of plant or machinery owned by the leasing company relates to leased plant or machinery. By selling the plant or machinery prior to selling the leasing company the Schedule 10 charge which would otherwise have arisen was avoided because when the leasing company was sold it did not own the plant or machinery assets.

The changes to Schedule 10 apply to remove the requirement that a leasing company should own the plant or machinery subject to leases for Schedule 10 to apply. There are also changes to the definition of the amounts from which any Schedule 10 charge is computed to tackle the manipulation of balance sheet values by leasing companies to reduce or avoid a charge arising under Schedule 10. Instead of the Schedule 10 charge being calculated on the difference between the tax written down value of plant or machinery and the net book value of plant or machinery per the accounts, the net book value has been replaced with the unencumbered market value of the asset in certain situations. HMRC have also made an amendment to remove an exclusion from Schedule 10 applicable when assets are sold at the same time under terms whereby the lessor retains an entitlement to the rentals associated with the assets.

The Government have asked for comments, in particular if businesses feel that the changes would have an adverse affect on commercial transactions.

Changes to the Film leasing rules

The Government have today published draft legislation to counter film lessors who previously took advantage of accelerated capital allowances in respect of investment in certain films now seeking to shelter the rental income in respect of the films by terminating the original lease and entering into a long funding lease of the film. A lessor under a long funding lease is only taxed on the interest element of rentals received. The proposed changes deny relief where a long funding lease of a film is entered into on or after 13 November 2008.

Our view
The changes appear to mean that a lessor entering into long funding lease of a film after 13 November 2008 could be taxed on the gross income under the lease with no tax relief for the cost of the film.