Long funding leases and capital allowances

Normally the lessor, as legal owner, claims capital allowances on leased plant or machinery. Where a lease is a long funding lease under sections 70A to 70YJ of the Capital Allowances Act 2001, the lessee is instead treated as owning the asset and claims plant and machinery allowances, provided no lessor above it is entitled to them. A long funding lease is, broadly, a lease that is economically a financing arrangement and runs for more than seven years.

Why does a lessee ever get the capital allowances?

HMRC’s guidance at CA23805 explains that the rules, introduced by Finance Act 2006, correct a distortion. A business that borrows to buy a machine owns it and claims allowances, while a business that takes the same machine on a finance lease has the same economic position but, before 2006, could not claim because the lessor owned the asset. The long funding lease rules move the allowances to the lessee where the lease is in substance a financing transaction. The lessor then gives up its allowances and is taxed only on the finance return.

The rules apply to leases finalised, or whose term began, on or after 1 April 2006. They apply to plant and machinery only. Buildings are dealt with separately, including through the structures and buildings allowance. For the ordinary rules on who can claim, see capital allowances explained.

What is a funding lease?

The lease must first be a plant or machinery lease: an arrangement treated as a lease under generally accepted accounting practice that gives the right to use plant or machinery. It is then a funding lease if, at its inception, it meets at least one of three tests:

• Finance lease test (section 70N). It is treated as a finance lease or a loan in the accounts of the person concerned, or for a lessor in the accounts of a connected person.
• Lease payments test (section 70O). The present value of the minimum lease payments is 80% or more of the fair value of the asset. Fair value is market value less any grants towards its purchase or use. The discount rate is the interest rate implicit in the lease or, if that cannot be found, the incremental borrowing rate.
• Useful economic life test (section 70P). The term of the lease is more than 65% of the remaining useful economic life of the asset.

A hire purchase contract is not a funding lease; the hirer already claims under the hire purchase rules. See hire purchase accounting. A lease is also not a funding lease where the current owner has previously leased the asset under leases that were not funding leases and whose combined term exceeded 65% of its useful economic life.

Which funding leases are not long funding leases?

A funding lease is a long funding lease unless it is one of the following:

• A short lease. For leases entered into on or after 1 January 2019, section 70I treats a lease with a term of seven years or less as short. For older leases the limit was five years, extended to seven only for leases accounted for as finance leases with a residual value of no more than 5% and level rentals. Anti avoidance rules stop the short lease test being met by splitting a longer arrangement between connected lessees.
• A lease of a ship to a tonnage tax company.
• An excluded lease of background plant. Where a building is leased together with plant such as lighting, heating or lifts whose main purpose is to make the building usable, the plant element is excluded. This does not apply where rents vary with the value of the lessor’s allowances or the arrangement is designed to keep the lessor’s allowances.
• A low value lease of plant fixed to property. Other plant leased with a property is excluded if its value is less than 10% of the value of the background plant and less than 5% of the market value of the property.

Lessor and lessee apply the tests separately, so a lease can be a long funding lease for one party and not the other.

When can the lessee actually claim?

Even where the lease is a long funding lease for the lessee, CA23810 explains that the lessee cannot claim if the lessor or any superior lessor is entitled to plant and machinery allowances at the start of the lease, or previously claimed allowances without bringing a disposal value into account when the long funding lease was granted. The lessee must be able to show this. If it cannot, it simply deducts the rentals in the ordinary way.

The mismatch can cut both ways. If the lessor does not treat the lease as a long funding lease, the lessor keeps the allowances and the lessee gets none. If the lessor treats it as a long funding lease but the lessee does not, neither claims. In a chain of leases only the long funding lessee lowest in the chain can claim.

The lessee must also file its return for the period in which the lease begins on the basis that the lease is a long funding lease, and cannot later use error or mistake relief to change that choice.

How much capital expenditure is the lessee treated as incurring?

The lessee is treated as incurring capital expenditure at the later of the start of the lease term and the date it first uses the asset in its qualifying activity. The amount depends on the type of lease:

Type of long funding lease	Lessee’s deemed capital expenditure
Long funding operating lease	Market value of the asset, ignoring the lease
Long funding finance lease	Present value of the minimum lease payments, as it would appear in GAAP accounts

Capital rentals paid before the lease term starts that are not otherwise relieved can be added. If the lessor later spends money on the asset and the present value of the lessee’s payments rises, the increase is further expenditure. Under an anti avoidance rule, where a main purpose is to obtain allowances on more than the asset’s market value, the expenditure is restricted to market value.

Worked example

Illustration only. A manufacturer leases a machine for eight years. The machine’s fair value is £100,000 and the present value of the minimum lease payments is £95,000. The lessor does not claim allowances. The lessee applies FRS 102 as amended in 2024 and recognises a right of use asset. The term is more than seven years, so the lease is not short, and £95,000 is more than 80% of £100,000, so the lease payments test is met. The lessee is treated as incurring £95,000 of capital expenditure when the lease starts and claims plant and machinery allowances on it, while its deduction for the rentals is limited to the finance charge.

What happens to the lessee’s deduction for rentals?

Because the lessee gets capital allowances, its revenue deduction for rentals is restricted so that relief is not given twice. BLM42030 explains that under a long funding finance lease the deduction is limited to the finance charges shown in GAAP accounts, under section 377 CTA 2010. Under a long funding operating lease, sections 379 and 380 CTA 2010 reduce the deduction by the expected fall in value of the asset over the lease, spread on a time basis. Income tax equivalents are in ITTOIA 2005 sections 148G to 148I.

How do IFRS 16 and right of use accounting change things?

Under IFRS 16 and the 2024 amendments to FRS 102, lessees no longer classify most leases as finance or operating; they recognise a right of use asset. BLM51030 explains that such a lessee cannot meet the finance lease test, so it can only have a funding lease through the lease payments test or the useful economic life test. In practice the lease liability will usually match the present value of the minimum lease payments, so most long leases will pass. BLM51035 confirms that a long funding lease accounted for as a right of use asset is taxed as a long funding finance lease, except that existing long funding operating leases are grandfathered when the lessee changes standard. See IFRS 16 leases overview and lessor accounting under FRS 102.

What happens when the lease ends, and what goes wrong?

The end of the lease is a disposal event for the lessee. Under a long funding operating lease the disposal value is the excess of the starting market value over the total rental restrictions, so net allowances equal those restrictions; any share of sale proceeds passed to the lessee is a further disposal value. Under a long funding finance lease the disposal value is based on the termination payment, adjusted on early termination.

Common errors include:

• applying the old five year short lease limit to leases entered into since 1 January 2019;
• claiming allowances without confirming that the lessor has not claimed them;
• deducting full rentals as well as claiming allowances;
• overlooking that a lessee under IFRS 16 or revised FRS 102 is taxed as a finance lessee;
• failing to file the first return on a long funding lease basis, which cannot later be corrected through error or mistake relief.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

Related Accountapedia entries

• Hire purchase vs leasing: the tax treatment
• Lease or buy: comparing the cost
• The 40% first year allowance from 2026
• How micro entities account for leases
• Deferred tax on leases after the 2026 changes
• Funding your company: loan or shares

Sources

• GOV.UK: Manual page CA23805
• GOV.UK: Manual page BLM00075
• GOV.UK: Manual page CA23830
• legislation.gov.uk: Act 2001 c. 2, section 70N
• legislation.gov.uk: Act 2001 c. 2, section 70O
• legislation.gov.uk: Act 2001 c. 2, section 70P
• legislation.gov.uk: Act 2001 c. 2, section 70I
• legislation.gov.uk: Act 2019 c. 1, schedule 14
• GOV.UK: Manual page BLM20510
• GOV.UK: Manual page CA23835

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.