Edited version of your written advice

Authorisation Number: 1012838481120

Date of advice: 13 July 2015

Ruling

Subject: Operating lease or finance lease

Question

Is the rental contract containing a clause that requires the lessee at their expense to dispose of the item and incur all associated costs of storage and disposal at the end of the rental period, considered to be an operating lease?

Answer

No

This ruling applies for the following period

Year ended 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

• the private Ruling application

• e-mail response and attached copy of contract

The company is involved in the long term rental of equipment.

In some cases the equipment has a useful life of 6+ years. For some equipment in long term rentals for a period of 4 years, it is a requirement of rental that the lessee disposes of the asset at the end of the rental term.

At the end of the lease the company will lift any PPSA registration in order to ensure there is no recourse.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Guidance about whether the Commissioner considers an arrangement to be an operating lease is set out in income tax ruling IT 28. Some of the more relevant paragraphs for this situation are set out below.

7. In short, it was made clear that, in determining the application of income tax legislation to this class of transaction, it was necessary to decide whether the payments were lease rentals or whether they were, in substance, consideration for the sale of the goods purported to be leased. In the latter case, of course, the payments would be outgoings of a capital nature which would not be deductible for income tax purposes.

8. Among the relevant factors which would determine this question are the following:-

(1) the existence of any agreement, express or implied, and whether in the lease agreement or in subsidiary documents or correspondence, under which the property in the goods would pass from the lessor to the lessee; and

(2) the degree of relativity between the "appraisal value" or "residual value" - by reference to which the amount of lease rentals was frequently determined - and the reasonable commercial value of the goods at the expiry date of the lease.

15. If, for instance, the arrangement were such as to confer on the lessee, if he chose to avail himself of the option, a right whereby the property in the goods would pass to him from the lessor at any point of time, the arrangement would, in my opinion, constitute for all practical purposes a contract for the sale of the goods. Similarly, I should not regard as a normal commercial lease an arrangement under which, on the termination of the lease or any extension thereof, the lessee was permitted or enabled to retain the use of the goods - as, for example, through the property in the goods passing to his nominee or agent. In these contexts, it is considered to be immaterial whether the lessee's right to secure the property in (or the use of) the goods was conferred in the head agreement or in some collateral agreement or agreements.

16. The inclusion in the agreement or agreements of a provision that the leased goods be disposed of, at the termination of the lease, otherwise than by way of public auction raises a presumption that the lessee has rights of purchase. Such agreements do not satisfy the minimum conditions herein being defined.

17. This is not intended, of course, as restricting or confining an owner's rights to dispose of his goods in any way he may choose after the leasing is completed. The objection is against provisions under which, prior to the termination of the leasing period, arrangements are entered into for the disposal of the goods other than by public auction.

18. Another factor that would be regarded as inconsistent with a finding that the transaction was a normal commercial lease would be the inclusion in the leasing agreement of a provision under which, in the event of the sale price of the goods falling short of an agreed residual value, the shortage should be paid by way of adjustment by the lessee to the lessor.

19. An unreal or nominal residual value in leases of relatively short term e.g. up to 5 years, would, I consider, raise a strong presumption that the transaction was something more than an ordinary commercial lease. By this it is not intended to convey that the residual value must necessarily correspond with the depreciated value of the goods for income tax purposes but it should, in my view, be in conforming with some generally accepted basis of commercial or industrial valuation.

Broadly speaking, for a lease agreement to exist there must be one party, the lessor, who owns the property, and a lessee in whom is vested a right of exclusive possession of the property for a given period after which the lessor has the right to regain possession.

In this agreement, the contract stipulates that at the end of the term of the lease the lessee agrees at their expense to dispose of the item, including all associated costs of storage and disposal. In such cases the company agrees to lift any PPSA registration in order to ensure there is no recourse.

The Personal Property Securities Act (PPS Act) treats long-term lease arrangements, known as 'PPS leases', as creating security interests in the property leased when the arrangement is for:

• an indefinite period

• a term or terms of up to one year or more for most goods, or

• a term or terms of 90 days or more in the case of serial numbered goods, such as motor vehicles or boats.

The reason for this is so that a third party, such as a buyer or potential lender cannot wrongly assume that the person who has possession of the goods has a right to sell or offer the goods.

The PPS Act does not generally consider the identity of the owner of the property subject to a security interest when determining priority between two or more security interests in the same property. For example, the lessor's ownership of the property will not determine who may have priority - it will be the priority rules in the PPS Act. A secured party could also lose their interest in the property if the security interest is unregistered and the property is subsequently sold or leased.

The act of the company lifting any PPS registration at the end of the term of the lease allows the lessee to deal with the property without any other party having a security interest in it. It would appear that they have been given the power to deal with the property as they see fit. They could continue to use the property for an indefinite period, in the same manner, as they have been for the period of the lease and then dispose of it. Even though there has been no legal transfer of ownership, the fact that they have possession and there is no registered security interest, they have the power to deal with the property as if they did have ownership.

We consider that, in effect the property in the goods is passing to the lessee at the end of the lease and this means it is not meeting the basic requirements of an operating lease as set out in IT 28. Therefore this agreement with the special term included regarding the disposal of the goods, is not considered to be an operating lease for income tax purposes.

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