A lease of relatively long-lived plant or machinery typically
generates tax losses in the first years, because the capital
allowances outstrip the income from the lease, and goes on to
produce tax profits in the later years, because the capital
allowances were then exhausted.
The availability of capital allowances to lessors has been
restricted by the long funding lease rules introduced by FA 2006
but capital allowances are still available on leased plant or
machinery, either because the leases pre-date the long funding
lease rules or because they are outside those rules.
Note also that the issues described here are as likely to
arise on, for example, the 7-year lease of a ship as they are on a
25-year lease of that ship.
Groups took advantage of the early tax losses by surrendering
them as group relief. A group looking to maximise the tax
advantages would then sell the lessor company to a loss making
group as the lease moved into the tax profitable phase. The new
group surrendered its losses to the lessor company so that no tax
was payable on the deferred profits. Where the new owner was a
long-term loss-maker the effect was to turn the capital allowances
timing advantage into a permanent deferral of tax.
Often, the lease would be terminated in the hands on the
loss-maker and the leased asset sold. The tax profit on selling the
asset was covered by losses surrendered by the new owner group.
The sale of lessors legislation deters this transaction by
treating as income an amount which reflects the timing advantage
gained from the capital allowances while the lessor company is in
the ownership of the selling group. On its own this would deter all
sales of lessor companies but the legislation goes on to treat the
lessor company as incurring an expense equal to the income amount
while the lessor company is in the ownership of the buying group.
When the buying group has profits the expense is valuable, it
may generate losses which are available to surrender as group
relief. The profit making buyer is not deterred from buying and is
likely to pay more for the shares in the lessor company,
compensating the seller for the tax charge suffered. When the
buying group has losses the expense brings no benefits and the
buying group will pay no more for the shares, leaving the seller
exposed to a charge. This sale becomes unattractive and is
deterred.
The legislation operates in a similar way where the
arrangements are intended to allow a profitable partner to access
the tax losses and a loss-making partner to shelter the taxable
profits.
