BIM61180 - Leasing: Finance lessees: pre-use rentals

In some `big ticket' arrangements amounts are paid by the lessee prior to the primary period (the `pre-primary' period) or in the primary period but while the asset is still in the course of construction or manufacture. These payments reflect the fact that the lessor will already have financed expenditure on the asset.

Payments in the pre-primary period will usually consist of only a finance charge (`interest only'). Payments made in the primary period may involve a further element being the balance of the full rent due under the lease (that is, the lessee will also be repaying some of the `loan' as well). The payments will either be capitalised or charged against commercial profits in the period in which they are incurred.

The finance charge (`interest') paid in the pre-primary period will also sometimes be capitalised. The amount capitalised then forms part of the cost of the rights to be written off under SSAP 21 and the deduction for tax purposes would normally follow the accounts treatment when that write off is made.

TAX TREATMENT OF PRE-USE RENTALS

Where the finance charge element (which will often be the whole of the payment):

• Is charged against commercial profits in the period in which it is incurred, and
• that treatment is in accordance with generally accepted accountancy practice,

the treatment is followed for tax purposes.

Non-finance charge element

Where the payment made prior to the time the asset comes into use also includes amounts in addition to the finance charge element, these amounts will, under SSAP 21, be set against the obligation outstanding and deducted from the outstanding `loan' in the balance sheet.

For tax purposes no further deduction is allowable in respect of the lease rentals (over and above the finance charge element) until the period of account in which the asset comes into use. The appropriate measure of the deduction, in addition to the finance charge element, due in that period will normally be the depreciation charge calculated by reference to the shorter of the lease term (normally including any secondary or later periods) or the asset's useful life.

In some cases there may be doubt over when an asset comes into use for the purpose of this approach. Evidence of the date that an asset is regarded as having come into use will normally be signalled by the date on which the rights in the asset start to be depreciated in the accounts drawn up under SSAP 21. This date should be used for tax purposes also, unless there is factual evidence to the contrary.