Annex 1: Minor changes in the law Change 55: Sale and lease-back etc: restriction of excessive lease rentals: relationship with accounting practice: sections 838 and 865
This change puts on a statutory basis HMRC’s published practice on the interaction between section 779 of ICTA (sale and lease-back: limitation on tax reliefs) and the accounting treatment for finance lease rentals.
The Inland Revenue set out in Statement of Practice 3/91 (SP3/91) its view on the timing of deductions for rentals payable by lessees under finance leases. It also published an article supplementing SP3/91 in the Tax Bulletin,February 1995 (TB15). The material in SP3/91 and TB15 is substantially reproduced in paragraphs 61105 to 61185 of HMRC’s Business Income Manual (BIM61105 to 61185).
Generally speaking, the effect of SP3/91 is that tax relief is given for finance lease rentals in the period in which they are charged in calculating the lessee’s accounting profit or loss. If a lessee makes a payment under a lease, and the economic benefit of the payment extends over several periods of account, then (broadly speaking) the accounting treatment is to charge the payment as expenditure in the periods of account to which the payment in economic substance relates. Thus under SP3/91 tax relief is not necessarily given in the period in which the finance lease rental payment is made; tax relief may be deferred to later periods.
Section 779 of ICTA is an anti-avoidance provision restricting tax relief for excessive rentals paid under sales and lease-backs of land. If it applies to a payment, tax relief for that payment is deferred (and may in certain circumstances be denied altogether). Section 782 of ICTA (leased assets: special cases) is a similar provision applying to transactions involving assets other than land. Sections 779 and 782 of ICTA apply for the purposes of both income tax and corporation tax.
HMRC’s practice, as published in TB15 and BIM 61105, is to apply SP3/91 before making any adjustments under section 779 of ICTA (see BIM 61105). Depending on the facts, this may mean that there is no need for any adjustments to be made under section 779 of ICTA.
FA 1998 introduced specific legislation which (broadly speaking) is to the same effect as SP3/91, but goes further. Section 42 of FA 1998 has been rewritten for the purposes of income tax and corporation tax in, respectively, section 25 of ITTOIAand section 46 of CTA 2009 (use of generally accepted accounting practice in calculating trade profits). Section 272 of ITTOIA and section 210 of CTA 2009 apply, respectively, section 25 of ITTOIA and section 46 of CTA 2009 in calculating profits of a property business.
Under section 25 of ITTOIA and section 46 of CTA 2009, trade profits are calculated in accordance with GAAP, subject to adjustments required or authorised by law. These provisions operate by reference to receipts and expenses to be brought into account, not by reference to payments made. But sections 779 and 782 of ICTA do not acknowledge GAAP. And they assume that tax relief is given for payments made rather than expenses brought into account. So there is a conflict. The Act resolves this in this way.
First, it acknowledges that a calculation for tax purposes is made in accordance with GAAP.
Second, it provides that, if deductions for tax purposes are allowed for (eg) the rental payments under a lease, the first step is to calculate:
Third, it then provides for the rules currently contained in section 779 or 782 of ICTA to be applied to the figure given by that calculation, so that the deduction allowed for the period is that figure as reduced by those rules (but is the unreduced figure if those rules do not require a reduction to be made).
Resolving the conflict in this way – rather than making the adjustments required by sections 779 and 782 of ICTA first and then applying GAAP to give relief for lease rental expenditure – could, in principle, affect the periods in which relief is given. This could be favourable to the taxpayer, adverse to the taxpayer or favourable to the taxpayer in some respects and adverse to the taxpayer in other respects. The extent to which it would be favourable or adverse would depend on the facts and, in particular, on the rental profile of the lease under review.
This change is in principle adverse to some taxpayers and favourable to others. But it is expected to have no practical effect as it is in line with generally accepted practice.