Introduction
When calculating the profits assessable to tax for a year it is not permissible to deduct expenditure which was not laid out wholly and exclusively in earning the profits for that year.
This long established principle, in the context of leasing payments was considered in the case of Gallagher v Jones in 1993 (STC 537) where it was decided that while the liability to pay the leasing charges was incurred during the year, it was not incurred in earning the profits for the year. The court determined that the way to ascertain the profits or losses of a business was to apply accepted principles of commercial accountancy (in this case the ‘accruals’ concept of matching the revenue and costs of the trader with one another so far as their relationship can be established or justifiably assumed) as these principles will normally afford the surest means of ascertaining the true profits or losses, as the case may be.
The conclusion drawn from this is that the allowable leasing costs should be spread over the economic life of the asset, and not simply the terms of the lease, and reflect net lease costs (ie take account of the residual value of the asset and also the ‘sale proceeds’ or market value - when the asset is either disposed of or no longer used in the trade).
Practical aspects of the above treatment
If the above were to be applied strictly, every lease agreement would have to be examined to determine the economic life of the asset involved, together with the anticipated residual value, and the lease payments spread accordingly. This is not being proposed.
It is an accepted fact that lease payments will often accelerate relief (particularly when compared with a capital allowances claim) and as long as this is not unreasonable in relation to the nature of the asset leased this acceleration is acceptable. When, however, the asset is either disposed of or taken out of the business an adjustment will need to be made in the computation to ensure that overall, the lease rentals claimed reflect (match) the use of the asset over the period it was used in the trade.
Where the whole ‘cost’ of the asset has already been claimed the calculation of the adjustment will be simple in that the whole disposal proceeds will need to be brought in.
Where, however, there are still lease rentals to be paid, account will have to be taken of that part of the sale proceeds that need to be passed on to the lessor.
Asset and vehicle examples for lease payments
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