403 Restriction on use of capital allowances for certain leased assets

Summary

This section ring-fences the leasing of machinery or plant so that, where it is carried on in conjunction with other activities (for example, a banking business), capital allowances on leased machinery or plant can be set off only against leasing income and not against any other income/gains. Where leasing is carried on by a company in a group of companies capital allowances on leased machinery or plant are not allowed to create losses for the purposes of group relief. However, where a business consists primarily of leasing the leasing ring fence is eased to provide a wider range of income against which leasing capital allowances and losses can be offset.

The restrictions do not apply in the case of —

• machinery or plant leased for use by the lessee for the purposes of manufacturing activities (this exception, however, does not apply in the case of a qualifying shipping trade – see section 407(6)) or in exempted trading operations at Shannon Airport, and
• leased films the making of which was assisted by the Irish Film Board.

The restrictions are effective from 25 January, 1984 but do not affect the set-off of expenditure incurred on machinery or plant under a leasing contract entered into before that day or during a grace period of approximately one month after that day. The section also contains an ancillary provision which eliminates a tax avoidance device, based on isolated leasing transactions, whereby individuals or companies sheltered non-leasing income from tax.

Details

Definitions and construction

(1) “chargeable period or its basis period” has the same meaning as in section 321(2), that is, the period (accounting period for corporation tax and basis period for income tax) by reference to which capital allowances are granted. Any such period which ends on or after 25 January, 1984 may be subject to the restrictions imposed by this section.

“the specified capital allowances” identifies the capital allowances which are subject to the restrictions provided for in this section. The allowances affected are, broadly, capital allowances in respect of machinery or plant provided for leasing on or after 25 January, 1984 (other than allowances to which subsections (6) to (9) apply).

“trade of leasing” identifies the leasing activities which may be affected by the section; these are —

• any trade which consists wholly of the leasing of machinery or plant, or
• where a trade includes such leasing, the leasing part of the trade, which is treated as a separate trade by virtue of subsection (2).

Leasing includes —

• the letting or charter of ships or aircraft (except the chartering of ships in the course of a trade of operating ships), and
• letting machinery or plant on hire.

The broad interpretation of leasing is designed to ensure (where tax case law might not so rule) that all of the activities that would be carried on by a person whose only business is leasing and hiring of machinery or plant are included in that person’s trade of leasing.

This broad interpretation of leasing is modified with respect to the letting on charter of a ship by a company in the course of a trade of operating ships. Without this modification, in the case of a genuine trade of operating ships, certain kinds of chartering which are in fact part of a trade or are genuinely ancillary to the trade would be removed from the ambit of the trade for capital allowances purposes.

In such cases there is no question of denying the normal offset of capital allowances to such a trade in respect of ships let on spot or voyage charter or on time charter. These are in fact normal features of a ship operator’s trade. Bare-boat charter would also be so treated where it is ancillary to such a trade.

Accordingly, in the case of a company carrying on a trade of operating ships, any chartering of ships by the company which under the normal rules relating to Case I of Schedule D would be treated as part of that trade (and not, for example, as a leasing activity chargeable under Case IV of Schedule D) are to continue to be so treated despite this section.

Relaxation of ring-fence

(1)(d) The range of income against which capital allowances on leased machinery or plant can be offset in the case of a business that consists primarily of leasing of machinery or plant is expanded. The type of company that can benefit from the relaxed ringfence rules is set out. Such a company is identified by reference to its activities.

(1)(d)(i) The company activities must consist wholly or mainly of leasing. This means that more than half of the activities must be leasing activities. This condition can be met by the company itself (Clause (I)), by the group of which it is a member (Clause (II)) or by the group of companies that are resident in the same country as the company of which the company is a member (Clause (III)).

(1)(d)(ii) Not less than 90 per cent of the activities of the company itself must consist of leasing activities or activities that are leasing related as set out in clauses (I) to (V). Not less than 90 per cent of the company’s activities must consist of a combination of the following:

• leasing of machinery or plant (Clause (I));
• the provision of finance to fund the type of assets that are leased by the company (Clause (II));
• the provision of leasing expertise in relation to the type of assets that are leased by the company (Clause (III));
• the disposal of machinery or plant acquired in the course of its leasing trade (Clause (IV));
• ancillary activities Clause (V)).

However, income from leasing short life assets which has been computed by reference to accounting principles in accordance with section 80A may not be covered by such allowances.

(1)(d) Where the activities meet the above conditions, then certain categories of income will be treated as income of the company against which capital allowances on leased machinery or plant can be offset. The income concerned is income from the activities outlined at subparagraph (ii) (see above) and gains on the disposal of assets acquired in the course of the leasing business. In calculating a gain on disposal of an asset, no reduction in a gain is allowed for any increase in value arising from inflation.

Treatment of leasing as separate trade

(2) Where leasing of machinery or plant is carried on as part of a trade by a company or an individual (that is, such leasing and other activities constitute a single trade), the leasing activities are to be treated for tax purposes as a separate trade and the profits arising from those activities are to be assessed separately. The purpose of this separation is to prevent the automatic set-off of capital allowances on leased assets against the general profits of the trade (including non-leasing profits) which would otherwise be available where such leasing forms a part of a wider business. The provision is particularly relevant to leasing activities which form part of the general trade of banks or similar financial institutions.

Where the income of a company which is otherwise wholly engaged in the carrying on of a trade of leasing includes small amounts of non-leasing income which are merely incidental to the carrying on of the leasing trade, it is not necessary to make any apportionments of profits or to make any restrictions of capital allowances under this section. In general, the purpose of the section is to prevent the avoidance of tax on significant amounts of non-leasing income by the use of tax-based financing. Inspectors need not enter into time-consuming restrictions or correspondence in relation to minor amounts of other income which may arise in the course of a genuine leasing trade.

Having, for the purpose of computing taxable profits or losses, isolated leasing and the associated capital allowances, it is then possible, as is provided for in subsections (3) and (4) to prevent the excess of capital allowances on leased assets over leasing income being set off against other income.

The separate trade treatment is not, however, to imply a different commencement or cessation of the leasing trade from the commencement or cessation of the general trade of which it is a part.

Any necessary apportionments of the receipts and expenses of a trade that includes leasing activities can be made for the purpose of isolating the profits attributable to leasing.

For example, where leasing is carried on as part of a banking business, it will be necessary to apportion expenses between the gross income from leasing and the gross income from the rest of the banking business to arrive at the net income in each case. Thus, a portion of the overheads, funding costs, etc of the whole business (including leasing) will be identified as attributable to the leasing activity and these will be deducted from the lease rentals received to arrive at the net leasing income. The “specified capital allowances” will be allowed to be set off only against that leasing income.

Ring-fencing of non-corporate traders

(3)(a) A loss for tax purposes sustained in a trade of leasing by a non-corporate trader cannot, to the extent that it is attributable to specified capital allowances, be set off against any profits/gains other than profits/gains from the trade of leasing. In effect, a ring-fence is constructed for tax purposes around the leasing trade and the specified capital allowances are to be confined within that ring-fence.

Under sections 381 and 382 capital allowances for a year of assessment, where they exceed the profits/gains of the trade against which they are claimed, may be treated as trading losses and relieved against any profits/gains of the year of assessment. Thus, surplus capital allowances of a trade of leasing could, in effect, be set off (apart from this section) against any other profits/gains of the year for which the allowances are due.

The set-off of surplus capital allowances is not available in the case of specified capital allowances. This is achieved by providing that a loss sustained in a trade of leasing, in so far as it is attributable to such specified capital allowances, is for the purposes of subsections (1) and (3)(b) of section 381 treated as reducing profits/gains of the trade of leasing only. Under section 381(1) the loss would, but for this subsection, be available against any income.

(3)(b)(i) A non-corporate trader carrying on a leasing trade may be able to avail of specified capital allowances and also of other capital allowances (for example, on leasing machinery which is grant-aided or which was provided for leasing before 25 January, 1984) in the year of assessment or he/she may have incurred an actual trading loss (because his/her expenses exceed his/her leasing income) in the year of assessment. In such a case maximum advantage can be taken of the capital allowances other than the specified allowances, or of the actual trading loss, in computing the amount of a loss to be relieved under section 381.

Under section 393 capital allowances must, before being used to create a loss, be used to cover a balancing charge. In such a case, only the amount of capital allowances in excess of such a balancing charge can be used for the purposes of a loss relief claim under section 381.

Any specified capital allowances in respect of the trade of leasing are to be treated as covering any such balancing charge in respect of that trade so that the maximum amount of any capital allowances other than the specified allowances can be used for a loss relief claim against non-leasing income. Thus, the limitation imposed by the balancing charge will be attributed primarily to the allowances (the specified capital allowances) which, because of this section, cannot be treated as available for relief against income other than non-leasing income.

(3)(b)(ii) A degree of flexibility is provided for with regard to the order in which —

• actual losses incurred in a trade of leasing (that is, an excess of expenses over lease rentals),
• specified capital allowances, and
• other capital allowances,

may be relieved against leasing income and non-leasing income under sections 381 and 392.

Section 392(2) provides that where an actual trading loss, together with capital allowances, is the subject of a loss relief claim under section 381 and the aggregate loss (that is, including the capital allowances) cannot be fully relieved, then the relief is to be treated as being given to the maximum extent possible in respect of the actual trading loss before being given in respect of the capital allowances. Because of the restrictions imposed on the extent to which specified capital allowances of a trade of leasing can be used for the purpose of loss relief, the priority established by section 392(2) could be unduly restrictive. Thus, it is provided that a claimant for loss relief under section 381 may specify the extent to which the relief is to be attributed to the loss (if any) actually sustained in the trade of leasing, the specified capital allowances or any other capital allowances.

Ring-fencing of corporate traders

(4)(a) Where specified capital allowances have created or augmented a loss in a company’s trade of leasing in an accounting period, the whole or part of the loss (“the relevant amount of the loss”) computed for the accounting period in respect of the trade of leasing is unavailable —

• for relief under section 396(2) against the company’s non-leasing profits of that accounting period, but may be set off under that section against leasing profits (which could, in the circumstances, only be leasing income of an earlier accounting period), or
• for surrender to another company for set-off against that other company’s profits by way of group relief, except to the extent to which the loss could be offset under section 420A against “12½% income” of the other company if the restriction on the offset of leasing losses in paragraph (b) of the definition of “relevant trading loss” in section 420A did not apply.

(4)(b) The amount referred to as “the relevant amount of the loss” (being the amount subject to these restrictions) may be the full amount of the loss where, for example, there is no actual trading loss (before capital allowances) and there are no capital allowances other than specified capital allowances so that some part of the specified capital allowances has been effectively set off against an actual trading profit to create the loss (in such a case the tax loss has been created entirely by treating specified capital allowances as trading expenses).

In other circumstances, however, an amount less than the whole of the tax loss will be restricted.

Where no capital allowances other than the specified capital allowances are taken into account in arriving at the tax loss, but there is also an actual trading loss and the amount of the tax loss is greater than the total amount of the specified capital allowances, then the restrictions apply only to the total amount of the specified capital allowances.

Where both specified and “other” capital allowances (for example, allowances in respect of IDA grant-aided plant) are involved, the restrictions may also apply to an amount less than the full tax loss. The amount to be restricted is the lesser of —

• the amount of the specified capital allowances (if that amount is less than the total tax loss), and
• the amount by which the total tax loss exceeds the amount of the “other” capital allowances.

Where the tax loss does not exceed the amount of the capital allowances which are not to be restricted (that is, capital allowances other than the specified capital allowances) no restriction is to be made.

Ring-fencing of non-trading leasing income

(5) Restrictions are imposed on the set-off of capital allowances on leased machinery or plant which, though the subject of a lease arrangement, is not leased in the course of a trade of leasing. For example, an individual or a company can purchase an item of machinery or plant and lease it to another person. The rentals received would be subject to tax under Case IV of Schedule D and the lessor would be entitled to the usual capital allowances against the rentals.

Where accelerated allowances (free depreciation or initial allowance) are claimed, the capital allowances will usually greatly exceed the rentals for the first year of assessment or the first accounting period in the case of a company. Before the enactment of this section, such a surplus of allowances over rentals could be used to reduce other income of the same year of assessment or accounting period (under section 305(1)(b) for income tax purposes and under sections 308(4) and 420(2) (group relief) for corporation tax purposes).

The existence of this relief against other income proved particularly attractive to high-rate taxpayers, and avoidance schemes were organised and marketed to exploit it (for example, containers for the shipment of goods could be readily acquired and leased by individuals or companies with the objective of shielding otherwise taxable income).

As an anti-avoidance measure, this provision ensures that capital allowances on machinery or plant provided for leasing, otherwise than in the course of a trade of leasing, are available for set-off only against the rentals received from the lease and not against any other income.

The restriction applies as respects —

• expenditure incurred on or after 25 January, 1984 on the provision of machinery or plant (initial allowances are claimed by reference to expenditure incurred), and
• machinery or plant first acquired on or after 25 January, 1984 (wear and tear allowances, including free depreciation, require that a claimant possesses the relevant item of machinery or plant).

The addition of the words “other than capital allowances in respect of machinery or plant to which subsection (6) or (7) applies” ensures that grant-aided machinery or plant (including films the production of which was assisted by the Irish Film Board), or machinery or plant provided by virtue of expenditure incurred on or after 25 January, 1984 under an obligation entered into before that date, can be excluded from the scope of these restrictions.

Certain fishing vessels

(5A) The ring-fencing provisions of the section have been relaxed in the case of lessors of certain fishing vessels in the Whitefish fleet. These are vessels on the Register of Fishing Boats and in respect of which Bord Iascaigh Mhara has certified that expenditure has been incurred for fleet renewal purposes in the polyvalent and beam trawl segments of the Irish fishing fleet (see section 284(3A)).

Where expenditure is incurred within a 6 year period starting on 4 September, 1998 (“the appointed day”) capital allowances claimed by corporate lessors in respect of these vessels can be set against other income or profits. Previously, this was a three year period, section 52(2) of the Finance Act 2001 extended it to a 6 year period ending on 3 September 2004. However, because of State Aid considerations and the need to get EU Commission approval for this measure, this extension only takes effect following an order by the Minister for Finance. This order has not yet been made. For individual lessors, the position is the same but only in respect of allowances relating to expenditure incurred in a 2 year period commencing on 4 September, 1998.

Exclusions

The following capital allowances are not subject to any of the restrictions on set-off :

• (6) capital allowances in respect of expenditure incurred before 25 January, 1984, or under contracts which were under negotiation on that date;
  [It is necessary to retain this provision since it is theoretically possible that machinery or plant could yet be provided under a contract entered into before 25 January, 1984 (for example, the machinery or plant for a factory might be provided in phases over a period of years under a single contract negotiated and agreed before the first phase).]
• (7) capital allowances on machinery or plant (not being either or both a film negative and its associated soundtrack, or a film tape or film disc) provided for leasing the cost of which has been grant-aided by the IDA, the Shannon Free Airport Development Co. Ltd or Údarás na Gaeltachta and on leased films assisted by the Irish Film Board. Except for films assisted by the Irish Film Board, this exception does not apply as respects machinery or plant provided for leasing as on and from 13 May, 1986 (“pipeline” cases had until 31 August, 1986 to finalise contracts);
• (9)(b) capital allowances on machinery or plant provided for leasing by a lessor to a lessee in the course of the carrying on by the lessor of relevant trading operations in the Shannon Airport Area or the International Financial Services Centre (IFSC). In order for this exception to apply, however, claims for capital allowances in respect of such machinery or plant must be confined to standard wear and tear allowances. This exception is not to apply to machinery or plant in respect of which a claim for accelerated capital allowances (either by way of an initial allowance or free depreciation) has been, or will be, made;
• capital allowances on machinery or plant provided for leasing from 13 May, 1986 for use by a lessee in a “specified trade” (that is, a manufacturing business or exempted trading operations in the Shannon Airport Area). Such machinery or plant is, in effect, exempted from the restrictions imposed by this section. The machinery or plant must be subject to a lease which includes an undertaking by the lessee that the machinery or plant will be used during a period of at least 3 years for the purposes of the lessee’s “specified trade”. This is the general position in the case of machinery or plant provided before 4 March, 1998. Where machinery or plant is provided on or after that day, there is a further stipulation if ring-fencing is not to apply. This requires that the machinery or plant cannot be used for the purposes of any other trade as, for example, would be the case if the machinery or plant were leased onwards by the lessee. The situation where machinery or plant could be seen as being used for the purposes of the “specified trade” of a lessor solely by virtue of the fact that the lessor has leased the machinery or plant to the lessee is catered for.

(8A) Notwithstanding the deletion of sections 445 and 446 the references to plant or machinery referred to in subsection (8) are preserved and this section applies with any modifications necessary to give effect to this subsection.

(9)(a) A “specified trade” is a trade which consists wholly or mainly of —

• manufacturing, including certain activities deemed to be manufacturing for the purposes of the 10 per cent scheme of corporation tax – see section 443 (This exception, however, does not apply in the case of qualifying shipping – section 407(6)), or
• exempted trading operations in the Shannon Airport Area.

(9)(c) & (d) Where a trade includes other activities it is to be treated as consisting “wholly or mainly” of the qualifying activities during a “relevant period” if 75 per cent of sales revenue comes from such activities (the “relevant period” is a period of 3 years during which the lessee will have undertaken to use the leased machinery or plant for the purposes only of the specified activities).

The lease must not be a lease between “connected persons”. This is necessary to prevent arrangements aimed merely at tax avoidance. If the lessee fails to fulfil such an undertaking, any relief from tax given to the lessor (for example, group relief for losses) because the capital allowances on the leased machinery or plant were not subjected to the restrictions imposed by this section may be recovered by an assessment on the lessor. Provision is made for the usual right of appeal to the Appeal Commissioners against such an assessment made by an inspector.

(9)(e) Excluded from this provision is machinery or plant provided for leasing before 13 May, 1986 or before 1 September, 1986 under contracts under negotiation before 13 May 1986. Such machinery or plant, if grant-aided, has the benefit of subsection (7). Otherwise it is subject to the restrictions imposed by this section.

Meaning of obligation and negotiation

(10)(a) An obligation is treated as having been entered into before a particular date where, in effect, a binding contract in writing had existed before the particular date and the lessor’s obligation to incur expenditure on the machinery or plant arose out of the contract.

(10)(b) By negotiations being in progress before a particular date between the lessor and lessee is meant, in effect, preliminary commitments or agreements having been entered into between the parties on or before that date.

Relevant Date: Finance Act 2021