Depreciating assets subject to hire purchase agreements
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For income tax purposes, certain hire purchase and instalment sale agreements entered into after 27 February 1998 are treated as a notional sale of goods by the financier (or hire purchase company) to the hirer, financed by a notional loan from the financier to the hirer. The hirer is in these circumstances treated as the notional buyer and owner under the arrangement. The financier is treated as the notional seller.
Generally, the cost or value of the goods stated in the hire purchase agreement or the arm's length value is taken to be the cost of the goods to the hirer and the amount loaned by the financier to the hirer to buy the goods.
The hire purchase payments made by the hirer are separated into notional loan principal and notional interest under a formula set out in the Income Tax Assessment Act 1997, and the notional interest may be deductible to the hirer to the extent that the asset is used to produce assessable income.
Under the UCA rules, if the goods are depreciating assets, the hirer is regarded as the holder provided it is reasonably likely that they will actually acquire the asset.
If these conditions are met the hirer is able to claim a deduction for decline in value to the extent that the assets are used for a taxable purpose, such as for producing assessable income.
If the hirer actually acquires the goods under the agreement, the hirer continues to be treated as the holder. 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 actually acquire the goods under the arrangement, the goods are treated as being sold back to the financier at their market value at that time. The hirer will need to work out any assessable or deductible balancing adjustment amount - 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: 27 Aug 2007QC 27892