Finance Leasing Manual - FLM31.75
Fourth condition: whether negative depreciation counts as 'normal rent'
A further issue is whether negative depreciation, representing
future rental income, is taxable as a trading receipt as it arises,
apart from Schedule 12, and therefore as 'normal rent'. For periods
before 1 April 1998 this issue was not relevant to leases where the
rentals are taxable under Schedule A - for such periods there is no
scope for arguing that negative depreciation is taxable under
Schedule A as it is recognised in the accounts. But it is relevant
to some existing finance leases, generating rentals taxable as
trading receipts. These existing leases are excluded from Part II
but they sometimes contain subordinate provisions which may cause
them to satisfy the other four conditions in Paragraph 3. Their
treatment under the fourth condition is therefore material to
whether they come within Part I or not.
The issue and our approach is described in detail in
paragraphs 17-25 of the article on Schedule 12 published in the
April 1997 issue of Tax Bulletin. Paragraphs 24 and 25 agraphs in
the passage quoted below are particularly noteworthy.
`Definition of lease within Part I-condition in paragraph
3(4) Schedule 12
17. What follows under this heading is only relevant for
lease rents taxable under Case I of Schedule D.
18. Paragraph 3(4) is satisfied (and so the lessor will be
caught if the other four conditions in paragraph 3 are met) if the
taxable measure of the rents from the lease, calculated under the
rules apart from Schedule 12 (the 'normal rent'), is less than the
accountancy measure of those earnings (the 'accountancy rental
earnings').
19. As stated in our Budget Day Press Release, one reason or
the enactment of these provisions was the uncertainty of current
law as it applied to lease rentals which were part of trading
profits. (There was no dispute in Schedule A cases: we accepted
that the taxable earnings were the rent to which the landlord was
'entitled') The Revenue's contention was that the taxable earnings
in trading cases could not be less than the income shown in the
commercial accounts where those earnings wholly derived from
revenue sources. This view is disputed by the leasing industry and
its professional advisers.
20. We stand by our previous view of Case I leases in
applying paragraph 3(4). Thus, we are prepared to accept that
paragraph 3(4) is not satisfied (and the lessor escapes Part I) for
a period of account if, for any Case I lease, the lessor can
demonstrate that:
- the earnings correctly shown in the commercial accounts for that or an earlier period (which in this context may fall before Budget Day) are calculated wholly by reference to rental earnings and not to any extent by reference to any future sum which, in tax terms, is capital; and
- the rentals due under the lease will fully repay the lessor's investment in the lease and also fully pay the lessor's return on investment.
21. This is on the grounds that, on our view of the existing law
in such a case, the 'accountancy rental earnings' will not exceed
the 'normal rents'. Hence the lessor will not satisfy the paragraph
3(4) condition and will escape Part I of Schedule 12 (since the
Schedule does not apply unless all five conditions in paragraph 3
are met).
22. By contrast, to the extent that those 'accountancy rental
earnings' earnings in fact represent a future capital sum, they are
themselves capital and cannot be taxed as rental income except
under Schedule 12. In that case, the 'normal rent' will be
correspondingly smaller and the lessor may satisfy paragraph 3(4);
if so, the lessor would be caught by Part I of Schedule 12 if the
other four conditions in paragraph 3 are met. Whether the 'normal
rent' represents income or capital is a factual question in each
case.
23. Certainly in cases where the lease provides for a capital
sum to be paid to the lessor only in exceptional circumstances
(such as if the lessee defaults or the asset is destroyed) we
consider that lessors should be able to demonstrate that the
possibility of such a sum has not been taken into account in
calculating the income shown in the commercial accounts.
24. The approach set out under this heading is likely to be
of particular importance for 'existing' Part I leases, as defined
in paragraph 27, Schedule 12. For 'new' leases Part II of Schedule
12 will tax as a minimum the 'accountancy rental earnings' whether
the 'normal rent' represents income or capital. This is because
only the condition in paragraph 3(1) has to be satisfied before
Part II applies: paragraph 16(1).
25. The approach set out under this heading is not relevant
for Schedule A lessors because the ) statutory measure of earnings
(the 'entitlement' basis) is the measure of the 'normal rent'- not
the accountancy measure as we contend under existing law for Case
I: paragraph 20(b) of Schedule 12. `
