Leased Assets: Who claims Capital Allowance?

In business, some companies prefer to lease certain assets to an outright purchase. The reasons for this may range from the need to preserve cash flow (i.e. flexible payment terms) to enjoying the technical expertise of the original owner of the asset. In accordance with the International Financial Reporting Standard (IFRS) 16, depending on some factors, a lease can be recognized and reported as either:

  1. An operating lease OR
  2. A finance lease

In taxation, the party to a lease arrangement (i.e. the lessee or the lessor) to claim capital allowance on the asset (assumed to qualify for capital allowance), depends on how the asset is classified; either as an operating or finance lease. The Companies Income Tax Act Cap C21 LFN 2004 (as amended) however cedes to the meaning of an operating and a finance lease to the accounting standard on leases.

OPERATING LEASE

An operating lease is a lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset to the lessee. Paragraph 18 of the Second Schedule to the Companies Income Tax Act Cap C21 LFN 2004 (as amended) provides that:

Where a company owning an asset:

  • has incurred capital expenditure in respect thereof; or
  • leases that asset to any person under an operating lease contract for use wholly, exclusively, necessarily and reasonably for the purpose of a trade or business carried on by such person,

the provisions of this Schedule shall apply, as though such expenditure were incurred for the purpose of a trade or business carried on by the owner or lessor and as though the owner or lessor were using the asset for the purpose of such last-mentioned trade or business in the way in which and for the period or periods during which the asset is in fact in the first-mentioned trade or business.

In other words, the lessor (i.e. the owner of the asset) is deemed to have incurred qualifying expenditure for the purposes of a trade or business carried on by it, hence entitled to claim capital allowance on the asset. This means that the lessee does have any entitlement to capital allowance.

FINANCE LEASE

A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset to a lessee. Paragraph 18 also provides that:

Where however an asset is acquired by any hirer or lessee under a finance lease contract the terms of which provide for the transfer of ownership, risks and reward to the hirer or lessee, the provisions of this Schedule shall apply in the same way as it applies to an asset acquired by any owner or lessor of an asset for the purpose of his trade or business, but shall so apply subject to the following modifications that is to say-

a. the qualifying expenditure within the provisions of this Schedule shall in relation to any asset so acquired under that contract, be limited to the amount of the total lease payments due from hirer or lessee, during his basis period excluding in the computation of such qualifying expenditure any interest or charges payable under the contract;

b. any reference in this subparagraph to any owner or lessor of any asset shall be construed as including a reference to a hirer or lessee under the finance lease contract and as excluding a reference to the person leasing the asset to the hirer or lessee under the contract.

This means that under a finance lease, it is the lessee that has the right to claim capital allowances on the leased qualifying expenditure. However, according to the provisions, the cost of the asset is restricted to the total lease payments due during a basis period, excluding the interest portion.

The Schedule further provides that the party claiming capital allowance on the qualifying capital expenditure is also entitled to claim investment allowance of ten per cent of such expenditure.

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