Finance Bill 2010: implications for leasing

We have summarised below the proposed changes outlined in Finance Bill 2010 which directly affect the leasing industry. In addition, we have highlighted other changes, such as the introduction of transfer pricing, which are also relevant to the Irish leasing industry.

Operating leases

Section 80A was originally introduced in the Finance Act 2004 and applied to short life finance leased assets. A short life asset is defined as an asset which has a useful life of less than 8 years. The section operated such that a lessor could elect under Section 80A not to claim capital allowances and to be taxed on the interest element of the lease. In effect the treatment afforded under Section 80A is such that the tax treatment is matched with the accounting treatment.

Finance Bill 2010 extends Section 80A to include certain short life operating leased assets. Consequently, regardless of whether the asset is held under an operating lease or a finance lease the accounting treatment applies.

This proposed change is a positive change as now short life assets will get a faster tax deduction than is currently available under the tax regime where the write off is over 8 years. This change, which has been advocated by the leasing industry for some time, will be widely welcomed.

However, the new provisions will apply to operating leases of short life assets which are in excess of a threshold amount, i.e. the treatment is limited to newly leased assets that will exceed the threshold.

In order to calculate the threshold limitation, the threshold period must be identified e.g. the previous accounting period. For existing portfolios of assets the amount of deduction for the capital cost of leased assets (i.e. accounting depreciation/impairments) will be limited to the amount of capital allowances claimed in the threshold period (i.e. the capital allowances claimed in the previous period). A tax deduction for the full accounting charge (whether by way of depreciation or impairment) can be claimed for those assets over and above the existing portfolio.

By way of an example, where the capital allowances claimed in the prior period were €1m, the maximum deduction (i.e. accounting depreciation/impairment) in the current period relative to those assets is limited to €1m. The only permitted increase is in relation to new assets purchased in the current period.

In a group scenario, this threshold amount is calculated by reference to the total value of all short life assets let on an operating lease which were owned by the group at the end of the accounting period preceding the period for which the election is made. Essentially, this means that the new treatment will only apply to any increases in the portfolio of assets held by the group.

This change is good news for new entrants to the Irish leasing market but has limited use for existing lessors in Ireland.

A change that had been sought and has not come through is to permit such S80A leasing income to be treated as falling within the leasing ringfence. Such an amendment would facilitate S80A leasing income to be combined with other leasing income on which capital allowances has been claimed and therefore treat them all as one trade. From a business perspective, it makes absolutely no sense not to facilitate such an offset so it is a pity to see an opportunity lost.

Anti-avoidance - capital allowance for lessors

Further amendments were introduced in the Finance Bill to align the tax treatment of lessors and lessees and to ensure that only one party to a lease can claim capital allowances for finance leased assets and short-life operating leased assets (i.e. where the useful life of the asset is eight years or less).

Currently, the test by which lessees are entitled to claim capital allowances on an asset is whether they bear the “burden of wear and tear” on the asset. Very often the terms of a lease were such that it was unclear who bore the burden of wear and tear. The Finance Bill intends to eliminate this treatment and update the test for claiming capital allowances.

This amendment applies to all finance leases and states that where a lessee bears the burden of wear and tear then the lessee and no other person can claim capital allowances.

The second amendment applies to operating leases and finance leases as defined under Section 80A of the Act (which applies to short life assets). This amendment states that where all of the following conditions are met the original “burden of wear & tear” test will apply:

• The lessors and lessee make a joint election that the lessee will claim the allowances, or
• Where the lessor is not a person within the charge to tax under Schedule D, the lessee elects

The lessor has elected under Section 80A (short-life assets regime) so as to be taxed on its accounting profits rather than through the capital allowances regime. The lessee only deducts an amount for lease payments equal to the amount of lease income on which the lessor pays tax under the Section 80A regime i.e. generally speaking the interest component of the lease rentals.

In this regard, it is important to note that cross-border lessors cannot make a section 80A election.

This provision affects accounting periods commencing after the passing of the Act and may affect existing transactions. Thus, this change will require careful consideration by any lessee currently claiming capital allowances on its leased assets. This provision should not impact operating leases of long-life assets (i.e. where the useful life of the asset is greater than eight years).

These changes aim to eliminate any tax mismatch between the amount treated as income by the lessor and the amount deducted as an expense by the lessee. This anti avoidance provision, whereby capital allowances can only be claimed by one party (and not both lessor and lessee) on the same asset is reasonable and cannot be considered unfair in any way. In any event, these changes are aimed at individuals rather than corporates.

This provision will apply from the date of the passing of the Act.

Foreign currency and case IV lessors

Currently if a company is carrying on a Case I leasing trade (i.e. taxable profits are taxed at 12.5%) capital allowances and losses forward are calculated in a company’s functional currency.

The Bill proposes the extension of this treatment to lessors carrying on a Case IV leasing activities ( i.e. non-trading lessors taxable at 25%).

This is a welcome provision as it removes the mismatch between non-trading and trading lessors in relation to foreign currency translations. However, in our experience equipment leasing was almost always considered trading.

Other relevant changes
Transfer pricing

The objective of the transfer pricing law is to ensure that an arm’s length price is charged for arrangements (an arrangement is widely defined as any agreement or arrangement of any kind whether or not it is, or is intended to be, legally enforceable) involving the supply or acquisition of goods, services, money or intangible assets between connected persons where the profits or losses of either company are chargeable to Irish tax as trading profits or losses. Corporates are connected where there is at least a 50% relationship, but can be connected in other circumstances.

The transfer pricing regime will not apply to financing activities, such as an isolated interest-free loan. Financial services treasury companies will need to evaluate the impact of the law on their loan books and other financing transactions. The law also will not apply to isolated IP transactions such as royalty-free structures, but again where the company is carrying on a trade of managing IP, a full review of transactions should be undertaken. The law applies to both domestic and cross-border trading transactions between companies and to Irish branches of foreign companies that are within the charge to Irish tax on their trading activities. Transactions between head offices and branches do not fall within the scope of the regime.

There is a full exemption for small and medium-sized entities. A small/medium-sized entity is one with a staff head count of less than 250 and an annual turnover of €50 million or less, or an annual balance sheet total of €43 million in assets or less, which figures are assessed annually on a group-wide basis.

Companies are required to have available records that would reasonably be required for the purpose of determining whether the trading income of a company is computed by virtue of the arm’s length principle. It should be possible to rely on counterparty documentation to meet the Irish documentation requirement. The law is to be interpreted in accordance with OECD transfer pricing guidelines and specifically mentioned are the report on intangible property and the report on cost contribution arrangements. As would be expected, tax treaty provisions take precedence over this law.

The legislation contains provisions for grandfathering of arrangements made before 1 July 2010.

We would recommend that inter group leases are reviewed to ascertain the impact of the transfer pricing legislation.

Financing transactions
Financing transactions for corporates could be adversely affected by a change that provides that relief from Irish withholding tax on interest payable by companies in the course of a trade to an EU/DTA resident recipient only applies where the EU/DTA country imposes tax that generally applies to interest payments received in the recipient’s country, or where the interest is exempt from income tax under a DTA (or a DTA existed when the interest payment was made). Further clarification is required and financing transactions may have to be reviewed in the context of this change.

Please do not hesitate to contact us for further information on this topic.

Declan Butler, partner, T+353 1 417 2822

Brian Forrester, partner, T +353 1 417 2614

Conor Hynes, partner, T +353 1 417 2205

Deirdre Power, partner, T +353 1 417 2448

Paul Reck, partner, T +353 1 417 2470