Finance Leasing Manual - FLM2.14

Finance lessor: tax treatment of 'capital' element

For the tax treatment of the capital element in the rentals, there is no accountancy model which can be followed. The capital element in the rentals is income for tax purposes, but for accountancy purposes it is loan repayment and a balance sheet item. The tax treatment of the capital element differs depending on whether the rentals are chargeable as a trading receipt under

• Schedule D Case I

• Schedule A.

Where the rentals are chargeable under Schedule D Case I, to decide when the capital element in the rentals is taxable ordinary accountancy accruals principles are followed. Normally, Schedule D Case I earnings are recognised in the period for which they are payable (as contrasted with the period in which they are payable or paid). For example, if rent of £1,000 is payable on 2 January 1998 for the two years ended 31 December 1999, £500 would relate to 1998 and £500 to 1999.

Schedule D Case I accruals principles also apply to the new Schedule A rules which apply to income tax cases from 1995/96 and to corporation tax cases from 1 April 1998.

For Schedule A cases to which the old rules apply income is, strictly, recognised in the periods in which the lessor is entitled to it; that is, when the rentals are due to be paid. But we are usually content to accept a Case I accruals basis used in the commercial accounts (see PIM 5040). Guidance on avoidance schemes which exploited the old Schedule A rules for income recognition is at FLM26.01 onwards.