BLM25145 - Defining long funding leases: miscellaneous definitions: avoidance - term of lease artificially shortened

In order to avoid the lease being classified as a long funding lease, the parties may enter into lease arrangements with the intention of presenting a lease as having a term that is shorter than what is intended.

For example, what is intended by a lessor and lessee to be a long lease might be structured as a short lease with an option to extend the term of the lease. Such a lease could be structured so that it was arguable that it was not ‘reasonably certain’ that the option to extend would be exercised.

The anti-avoidance rule in CAA01/S70YF (5) has the effect of reversing the ‘reasonable presumption’ test. It applies where

• at the commencement of the lease term

• the term of the lease would otherwise be no more than 5 years (and so a short lease), and
• the lessee has one or more options to extend the lease term and on the assumption the lessee would exercise that option (or options) the term would exceed 7 years, and
• on failing to exercise any one of those options, the lessee may be required to make a payment to the lessor that would not have been payable had the option been exercised.

Where these conditions are met then the term of the lease is arrived at by assuming the options will be exercised unless, at inception, it is reasonably certain that the option or options will not be exercised. Note this reverses the normal ‘reasonably certain’ test and there will need to be strong evidence if it is be assumed that the option or options will not be exercised. Simple lack of evidence one way or the other means that it must be assumed the option or options will be exercised.

Note that there is no purpose or motive test and, whilst this rule is intended to prevent avoidance, it will also apply to any case where the initial 5-year period may be extended so that the lease term would exceed 7 years and the other conditions are met.