Finance Leasing Manual - FLM11.42

Premature termination of finance lease

On premature termination of a finance lease, payments may occasionally be made which are not in the nature of adjustments to past rentals, but represent a charge imposed on the lessee as consideration for being freed early from his obligations under the lease. Where the assets leased are used as capital assets in the lessee's business the lease itself is such a capital asset (see RTZ v Elliss, 61 TC 132, especially page 172) and an exit charge of this kind would be capital (see for example Mallet v Staveley, 13 TC 772 and IM 602).

Whether a payment is an adjustment of past rentals or is capital in nature will depend on the facts of individual cases. For example

• a termination payment equal to total undiscounted future rentals, otherwise payable over a considerable period, would prima facie contain a capital element;

• a payment calculated by discounting future rentals due and by taking into account the value of the asset on the premature termination would normally be revenue;

• an adjustment reflecting an enhancement of the lessor's return on his investment to compensate for, say, additional administrative costs or reinvestment risk would be consistent with the view that an exit charge was wholly an adjustment of past rentals and therefore wholly revenue.

Further guidance on termination payments is at FLM12.74 onwards.