Depreciating assets subject to hire purchase agreements
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For income tax purposes, certain hire purchase agreements entered into after 27 February 1998 are treated as notional sale and notional loan transactions.
Generally, the cost or value of the goods stated in the hire purchase agreement (or, if the parties were not dealing with each other at arm's length, the amount the notional buyer could reasonably have been expected to pay to buy the goods under an arm's length sale) is taken to be the cost of the goods to the hirer (the notional buyer) and the amount loaned by the financier (the notional seller) to the hirer to buy the goods. If the goods are depreciating assets, this same amount is taken to be the first element of cost for the purposes of calculating any deduction for decline in value. It would be subject to cost adjustments, including the car limit-see The cost of a depreciating asset.
In relation to the notional loan, the periodic payments are separated into principal and interest, the interest being deductible to the hirer.
In relation to the notional sale, the hirer is treated as the owner of the goods. Under the UCA rules, if the goods are depreciating assets, the hirer is the holder and is able to claim a deduction for decline in value if the asset is used for a taxable purpose-see When does a depreciating asset start to decline in value?.
If the hirer acquires the goods under the agreement, the hirer continues to be treated as the owner. Actual transfer of legal title to the goods from the financier to the hirer is not treated as a disposal or acquisition.
On the other hand, if the hirer does not legally acquire the goods under the arrangement, the goods are treated as being sold back to the financier at their market value at that time. This constitutes a balancing adjustment event for the hirer and an assessable or deductible balancing adjustment amount may arise-see What happens if you no longer hold or use a depreciating asset?
The notional loan amount under a hire purchase agreement is treated as limited recourse debt-see Limited recourse debt arrangements.
Last modified: 01 Jun 2005QC 27399