Clause 63

Finance Bill – in a Public Bill Committee at 4:30 pm on 16th June 2009.

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Leases of plant or machinery

Question proposed, That the clause stand part of the Bill.

Photo of Jimmy Hood Jimmy Hood Labour, Lanark and Hamilton East

With this it will be convenient to discuss the following: that schedule 32 be the Thirty-second schedule to the Bill.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury)

The clause and schedule relate to long funding leases of plant and machinery and to anti-avoidance. Long funding leases are a special type of lease that, following the Finance Act 2006, break with the traditional rule that the owner of the asset is the person entitled to any capital allowances available in respect of it. Instead, under a long funding lease, the lessee—the person to whom the asset is being leased—has the right to claim allowances.

The measures in schedule 32 were announced on 13 November 2008, just before the pre-Budget report, and seek to address the following problems, most of which look to us like genuine loophole avoidance and ought to be blocked. The explanatory notes to the clause, particularly the “Background Note” from paragraph 38 onward, indicate that the measures arise out of disclosure, but give only a broad indication of the problems with key definitions such as that of sale and leaseback.

It is thought that the offending schemes worked along the following lines. First, before 13 November 2008, it was possible for the owner of an asset to sell the right to future rentals from the asset, then grant a long funding finance lease of the asset to a third party—again, usually a connected party; perhaps another group company—and then take the asset back from that third party on a long funding operating lease under the Finance Act 2006. The combined accounting treatment lead to the owner receiving capital allowances equal to the market value of the asset that he was still using under the operating lease. The mechanics of the scheme seemed to turn on the fact that, by selling the rentals first, the net investment that has to be recognised for accounting purposes at step 2—on the grant of the finance lease—is greatly and artificially devalued. However, on taking the asset back under the operating lease, the owner is deemed to incur expenditure equal to the  current market value of the assets—on the one hand, the value is being depreciated and, on the other hand, the current market value is being used.

Secondly, where an asset had appreciated in value, it could be advantageously sold and leased back under a long funding lease because the sale proceeds could be limited to the unappreciated value. However, the capital allowances under the lease back would accrue to the former owner at the current market value, thereby giving an uplift. Thirdly, before 13 November 2008, at the end of a lease, the asset owner could avoid bringing any disposal value into account if a residual value guarantee agreement was in place. Fourthly, a leasing company that is part of a group could avoid the charge imposed under schedule 10 to the 2006 Act if it wished to leave the group by selling its assets and leasing them back, so that it ceased to own them in that sense for tax purposes. The book value of such a company for schedule 10 purposes was thereby depressed.

Schedule 32 will operate as follows. Paragraphs 1 to 5 prescribe the current market value of the asset to be the disposal value on the grant of a long funding finance lease, thereby targeting steps 1 and 2 of the first scheme that I outlined, as well as the second scheme. The concept of net investment is abolished. Paragraphs 6 to 8 effectively prescribe the disposal value on lease termination for the purposes of calculating the balancing charge, so that a disposal value has to be brought into account regardless of any guarantee arrangement. That will put a stop to the third scheme.

Paragraphs 8 to 11 provide that if the capital payment made on the grant of a long funding lease is brought into account as a disposal value, to the extent that it is so brought into account, it will not bear income tax under section 785C of the Income and Corporation Taxes Act 1988. That appears to be a tidying up exercise that will assist taxpayers. Paragraphs 12 to 14 will prevent the annual investment allowance and first year allowance being claimed by the lessees. Paragraphs 15 to 17 deal with leases made in favour of connected persons—providing a further impediment to the first scheme—but they are principally aimed at ensuring that market value is used for schedule 10 purposes where the owner has become lessee of his own assets. Paragraphs 18 and following repeat the exercise for plant and machinery taken on hire purchase agreements. All in all, there is nothing here of great controversy and I can see nothing that the Opposition would oppose.

Photo of Stephen Timms Stephen Timms Financial Secretary (HM Treasury) (also in the Department for Business, Innovation and Skills)

I am grateful to the hon. Gentleman for his explanation and support for the clause. As he said, the schedule introduces legislation to counter avoidance involving the leasing of plant or machinery—avoidance that was disclosed to HMRC under the disclosure rules. The schedule also deals with a technical defect in the Capital Allowances Act 2001 that could lead to a loss of tax when a long funding lease ends.

The disclosed schemes involve sale or lease and leaseback that is designed to provide tax relief by way of capital allowances in excess of the net capital cost of the asset to the person entering into the arrangements. As the hon. Gentleman described, arrangements are used that result in the disposal value brought into account for capital allowance purposes being less than the capital allowance relief that can be claimed on reacquisition of the asset under the leaseback. The measure deals with that.

On the technical defect, under the long funding lease rules, a lessee is entitled to claim tax relief for the leased plant or machinery. When the lease ends, an adjustment may be needed to ensure that the total relief is limited to the lessee’s costs. It became apparent last autumn that if the lease is structured in certain ways, the lessee might obtain relief in excess of their expenditure. The measure ensures that at the end of a long-funding lease, a lessee obtains relief for no more and no less than the amount they paid.

The measure also corrects a minor flaw in the definition of sale and leaseback transactions. It makes small changes that ensure that initial payments under a lease are taxed in full and that ensure consistency with the taxation of chargeable gains.

Photo of Greg Hands Greg Hands Shadow Minister (Treasury) 4:45 pm, 16th June 2009

The Minister might already have explained this but what is the flaw that has been corrected?

Photo of Stephen Timms Stephen Timms Financial Secretary (HM Treasury) (also in the Department for Business, Innovation and Skills)

I am glad to do so. As the law stands, the sale of plant or machinery followed by a leaseback to someone connected to the other seller who was already leasing the asset does not fall within the existing definitions. This arrangement, although not common, could be used to take sale and leaseback transactions outside the scope of the existing anti-avoidance rules.

The hon. Gentleman referred to the fact that draft legislation was published on 13 November last year. As is normal with anti-avoidance rules, the main provisions will have effect from the date of publication. The amended definitions, the change to the taxation of an initial payment and the amendments to the taxation of chargeable gains rules will apply from 22 April 2009, in line with the Budget date. As well as protecting the Exchequer, early publication allowed time for comments from businesses and their advisers. There has, however, been little comment on the measure; no concerns about any unintended effects have been expressed by businesses. I am grateful for hon. Members’ support and I ask that the clause and schedule stand part of the Bill.

Question put and agreed to.

Clause 63 accordingly ordered to stand part of the Bill.

Schedule 32 agreed to.