Revenue Note for Guidance
This section prevents an unintended use of the capital allowances regime in relation to certain leases of plant and machinery.
Certain leases of plant and machinery were structured in a manner designed to allow accelerated allowances in the early stages of a lease while postponing the taxation of lease receipts until the end of the lease. The result was that the lessor was able to use the accelerated capital allowances to shelter taxable income arising from other activities.
In the case of a long lease, the lease is effectively a loan. The lessor provides an asset costing, say, €1,000. The lease payments over the lease period amount only to the equivalent of interest on a loan of €1,000 (that is, about €80 per annum). At the end of the lease period a payment equal to the cost of the asset is made to the lessor. As a result capital allowances of €1,000 or €500 (depending on circumstances) could, but for this section, be taken in year 1 while the €1,000 receipts would not be taxed until the end of the primary leasing period. The section prevents this Exchequer cash flow loss by ring-fencing capital allowances on leased machinery or plant to income from the particular lease concerned. This ring-fence applies unless the lease meets certain conditions. As a general rule the ring-fence applies unless the lease payments are spread evenly throughout the primary lease period. In a 10 year lease, for example, one could expect to see 1/10th of the total lease payments received and taxed by the end of year 1, 2/10ths of total lease payments received and taxed by the end of year 2 and so on. The section allows some flexibility by requiring 91 per cent satisfaction of such a requirement in year 1, 92 per cent in year 2, 93 per cent in year 3 and so on.
Special rules are provided in the case of long leases of plant and machinery used for certain grant-aided projects (those in respect of which “section 130” funding remains available). Under these rules, the ring-fence does not apply despite the fact that, in the first 3 years of a lease which has a primary leasing period of 10 years or more, the only lease payments made are the equivalent of interest payments on the original cost of the asset. However, in such a case there has to be a pure even spread of payments over the remaining part of the primary lease period.
The section allows for restructuring of leases provided that it can be shown that the restructuring is carried out for bona fide commercial reasons. If, however, leases are restructured to take advantage of any benefits which may be provided by the section and not for bona fide commercial reasons, the ring-fence applies. Similarly, if arrangements are made for the sale and leaseback of any machinery, other than new machinery, the ring-fence applies unless there is a pure even spread of lease payments in the primary lease period.
The section does not apply to leasing in the course of an International Financial Services Centre (IFSC) or Shannon trade. In addition, short leases of assets costing up to €63,500 which involve regular annual payments with no backloading need not be subjected to the detailed tests set out in the section.
(1)(a) “agricultural machinery” is machinery or plant —
“asset” is machinery or plant. The section does not, therefore, apply to buildings.
“fair value” is essentially the cost price of the asset on the arm’s length basis at the inception of the lease.
“inception of the lease” is the earlier of the date on which the asset is brought into use or the date from which lease payments first accrue.
“lease payments” are the payments made under the lease and includes any payment made at or after the end of the lease period where the payment is guaranteed by the lessee or a person connected with the lessee. If the payment is guaranteed by a third party who is not connected with the lessee, the payment is not to be regarded as a lease payment unless the guarantee is part of an arrangement between the lessee and any other person.
“predictable useful life” is the useful life of the asset as estimated at the inception of the lease on the assumption that there will be normal usage of the asset.
“relevant lease payment” is the amount of a lease payment to be made under the terms of the lease. In certain cases it may not be possible to determine the amount of a lease payment because the lease provides for variable amounts which cannot be determined at the inception of the lease. A mechanism to determine the lease payments is provided which requires that, if lease payments are to be determined by reference to EURIBOR (the European Inter Bank Offered Rate) or a similar rate, the payments under the lease are to be calculated as if the particular rate which applies at the inception of the lease does not change. In this way it will be possible to determine at inception of the lease whether or not the lease falls foul of the section.
“relevant lease payments related to a chargeable period or its basis period” are relevant lease payments which are received in the period concerned and which are taxable in that period or in an earlier period. Where payments are anticipated on the assumption of interest rates, the test as to whether payments are taxable is applied as if the anticipated payments were the actual payments to be made.
“relevant period” is the period beginning at the inception of the lease and ending when the lessor has recovered 90 per cent of the investment in the asset. If, however, the relevant period is determined at more than 7 years, the relevant period is to be recalculated on the basis that it is the period in which 95 per cent of the lessor’s investment is recovered. In order to avoid a situation where taxpayers would seek to extend the relevant period by spreading payments over an unacceptably long period, it is provided that the relevant period will end at the end of the predictable useful life of the asset if that is earlier than the time at which the appropriate proportion of the lessor’s investment in the asset is recovered.
It is necessary to define relevant period in this way because the lease period can extend indefinitely in the case of a finance lease where the lessee is allowed continued enjoyment of the asset. In addition, the concept of the recovery of the lessor’s investment is borrowed from SSAP21 and should be understood by accountants and advisors.
The recovery of the lessor’s investment is to be measured as follows. Payments under the lease are taken where the lease specifies the payment. Where the payments are variable, amounts are to be determined using assumed rates. Payments are then to be discounted to their net present value at the inception of the lease. The earliest time at which the cumulative net present value of payments amounts to or exceeds the given percentage of the fair value of the asset (that is, its original cost) is the end of the relevant period. Lease payments are to be discounted at the rate implicit in the lease (that is, the rate which, when applied to all payments under the lease, produces a net present value at inception of the lease which is equal to the cost of the asset at inception of the lease).
The relevant period will not necessarily be the period after which the lease payments will be negligible. There can be substantial amounts payable after the end of the relevant period. The relevant period is simply a defined period in which the primary tests to determine whether a lease is a relevant lease is to be applied.
The notes on section 321 should be consulted for guidance on the meaning of “chargeable period”, “chargeable period related to” and “chargeable period or its basis period”.
(1)(b) Two tests are to be applied to leases in general to determine whether they are relevant leases.
(1)(b)(i) To avoid being a relevant lease, the cumulative taxable lease payments in an accounting period (where the lessor is a company), or in a basis period (where the lessor is an individual), which falls wholly or partly within the relevant period and in any earlier such accounting period must not be less than the proportion of total lease payments in the relevant period which has expired at that time. Some flexibility on this requirement is permitted by allowing for a gradual rise, on a cumulative basis, from approximately 90 per cent of such a requirement in the early stages of the lease to full satisfaction of the requirement by the end of the primary lease period.
This requirement is set out as a formula:
90 + (10 × W) |
|
W × P × |
|
100 |
W is the proportion of the primary lease period which has expired, being the period which has expired (E) divided by the length of the relevant period (R). That proportion is applied to the total lease payments (P).
The second part of the formula —
90 + (10 × W) |
100 |
relaxes the requirement by allowing the lease not to be treated as a relevant lease if it 90 per cent (approximately) satisfies the test in the early stages of the lease (when very little of the relevant period has expired). That requirement builds up over the relevant period so that at the end of the relevant period the test must be fully satisfied.
Any balance of payments due under the lease, other than an amount which is inconsequential, is to be paid within a given period which begins immediately after the end of the relevant period. In the case of a lease with a relevant period of 7 years or less, the balance must be paid within a period equal in length to 1/7th of the length of the relevant period, or 1 year if that is greater. In the case of any other lease, the balance must be paid within the period equal in length to 1/9th of the length of the relevant period, or 1 year if that is greater.
(1)(b)(ii) The rules to be applied to determine whether certain leases of machinery or plant constitute relevant leases are set out. The leases concerned are leases the relevant period of which exceeds 10 years and which concern machinery or plant —
A lease in this category is to be treated as a relevant lease (and the ring-fence applied) unless 3 conditions are met.
The first condition is that in each of the first 3 years of the primary lease period an amount must be paid which is equivalent to interest on what might have been borrowed to finance the purchase of the machinery or plant. Again, this is set down by a formula. The formula is —
D |
80 |
|
× |
||
100 |
100) |
The second condition is that in the remaining part of the primary period there must be a pure even spread of lease payments, that is, similar to the general rule except that there is no 90 per cent flexibility.
The third condition is that any outstanding amount at the end of the primary lease period, other than an amount which is inconsequential, should be paid within a period of 1 year immediately after the end of the relevant period. If a lease in this category meets those conditions, it is not a relevant lease and, consequently, capital allowances are not to be ring-fenced.
(1)(b)(iii) Under a finance lease the lessee pays lease payments in the primary lease period which represent the full cost of the asset plus compensation for the delay in the lessor’s recovery of his investment in the asset. In effect, the lessee has acquired the asset at that point and will in general be entitled under the lease to its continued use for an nominal or “inconsequential” amount. An inconsequential amount in respect of relevant lease payments is the nominal payments which may be payable after the primary lease period. This amount is capped by providing that an amount is to be regarded as inconsequential if the discounted present value, at the end of the period in which the balance of lease payments is to be paid, of future lease payments does not exceed 5 per cent of the cost of the asset or, if it is lower, €2,540. The rate to be used in this discounting exercise is the same rate as applies to determine the relevant period.
(1)(b)(iv) The rules for applying the section to an accounting period which crosses the start or the end of the relevant period or, in the case of “special project” leases, the period of the first 3 years of the period in which a pure even spread is demanded are that such an accounting period is to be split into 2 accounting periods, one before and one after the relevant date and the tests applied to the lease on that basis.
(1)(b)(v) A lease that is denominated in a foreign currency is not to be regarded as a “relevant lease” and subject to the ring fence by reason only of exchange rate differences.
(2) Subject to subsection (2A) where machinery or plant is let in the course of a trade carried on by the lessor, the letting of the asset under the relevant lease is to be treated as a separate leasing trade separate to any other activities of the lessor, and the restrictions in section 403 are to apply to that separate trade. The effect of the provision is to ring-fence capital allowances on the machinery or plant to income arising from that specific lease.
A similar ring-fence is to be applied to capital allowances (that is, initial allowances made in respect of expenditure incurred on the provision of assets or wear and tear allowances) on lease assets where the leasing is not part of a trade. The set-off of capital allowances against income other than income from the particular lease is prohibited where the set-off would be under —
(2A)(a) A “relevant long-term lease” is a lease of an asset that has a predictable life exceeding 8 years. Other expressions have the same meaning as in section 80A.
(2A)(b) Where a lease that is a relevant lease is also a relevant long-term lease, capital allowances from the lease may be offset against income from other relevant long-term leases of the company. This is achieved by applying the section subject to a number of notional changes.
This section will apply as if —
The above revised rules would allow capital allowances to be set off as follows:
(3) Some flexibility is allowed in the case of agricultural machinery whether it is used by a farmer for the purposes of the farming trade or by an agricultural contractor for the purposes of such a contractor’s trade. The provision allows the test to be applied to notional lease payments calculated by taking an average of lease payments made in the year concerned and the previous year. This makes some allowance where the lease provides for seasonal payments.
(4)(a) Subject to subsection (4A) where, in an effort to avail of any flexibility allowed by the section, lessors and lessees restructure leases which are on a straight-line basis or are front-loaded, any lease resulting from such arrangements is to be a relevant lease.
Unless it is shown that any restructuring was carried out for bona fide commercial reasons, restructuring which results in a higher level of payments being payable after any time, as compared with the level which would have been payable at that time, will have the effect of the lease concerned being treated as a relevant lease. This applies where the restructuring involved either —
This provision applies to such arrangements made after 11 April, 1994 and treats both the new and the old lease as a relevant lease, even where the original lease commenced before that date. If a lease is to be treated under this provision as a relevant lease, any allowance made which would not have been made in the case of a relevant lease is to be withdrawn.
(4)(b) The mechanism for withdrawing relief is that the withdrawal is made for the chargeable period related to the event giving rise to the withdrawal of the allowance and any such withdrawal is to be made in accordance with paragraph (c). The chargeable period related to the event means the year of assessment in the basis period for which the event takes place where the lessor is an individual. Where the lessor is a company it is the accounting period in which the event takes place. In addition, it places the responsibility on the lessor who is to suffer the withdrawal of the allowance to include in the tax return for that year both details of the event giving rise to the withdrawal and the amount to be treated as income.
(4)(c) Where relief is to be withdrawn, such amount (“the relevant amount”) of allowances as were made to the lessor but which would not have been made if the lease were a relevant lease at the time are to be treated as income of the chargeable period in which the restructuring takes place, subject to that amount being increased by an amount determined by the formula —
R |
||
A × |
× M |
|
100 |
A |
is the relevant amount. |
R |
is 0.0273 (the rate at which interest is chargeable on overdue tax). |
M |
is the number of days in the period beginning on the date on which tax for the chargeable period in which the allowance was made was due and payable and ending on the date on which tax for the chargeable period for which the withdrawal of the allowance is to be made is due and payable. |
(4A) In certain cases, an alteration to the terms of a lease will not result in the lease being regarded as a relevant lease and, therefore, subject to the ring fence.
(4A)(a) A lease is treated as a relevant lease if it does not have a fairly even spread of lease payments. An exception to this is a lease that was in place before 23 December 1993. In addition, certain leases were subject to a modified test under subsection (1)(b)(ii) of this section. Generally, where the terms of a lease which is not a relevant lease are altered, so as to backload payments, the lease will be regarded as a relevant lease.
(4A)(a)(i) Where the terms of a lease entered into before 2 February 2006 and which would be a relevant lease apart from the fact that it was either in place before 23 December 1993 or was subject to the modified text in subsection (1)(b)(ii) of this section, the lease will not be treated as a relevant lease because of that alteration.
(4A)(a)(ii) The alteration to the terms of the lease is to be disregarded as respects the tax treatment of any defeasance payments under the lease.
However, the tax treatment of the defeasance payment may change if the value of a lease payment, other than a lease payment that is based on a rate of interest, were to be reduced.
(4A)(b) The above rules do not apply if the alteration results in a lease payment being made more than 20 years after the time that it would otherwise have been payable.
(5) A lease of machinery or plant arising out of a sale and leaseback arrangement is a relevant lease unless the machinery or plant is new or there is a pure even spread of lease payments. The purpose of this is to prevent owners of assets reorganising their affairs so as to obtain any benefits they may see in the new rules and which would involve an Exchequer cost.
These restrictions apply where a person who owned an asset sells the asset and that person or a connected person takes the asset on lease from the person to whom it was sold or a connected person.
New assets are excluded because, for example, a specialist asset which is to be used by a trade may be purchased by the trader and sold to a financial institution for leasing to the trader or a connected person. Commercial realties may dictate that method as the most efficient way to acquire the asset. What the section seeks to prevent is the sale and leaseback of machinery or plant which is carried out principally for the purposes of availing of any tax benefits under the arrangements provided for by this section.
(6)(a) This section applies as on and from 23 December, 1993, (that is, the date of the announcement that the provisions would be introduced). However, excluded from the ambit of the section are —
(6)(b) The special method of calculating capital allowances referred to above concerns capital allowances on machinery and plant that is used in a chargeable period but is not used throughout the chargeable period is set out. The allowances on those assets are to be proportionally reduced on a time basis by reference to the part of the chargeable period throughout which the machinery or plant is used.
Relevant Date: Finance Act 2021