I have a client who very recently (and without giving me any notice) signed three 25 year leases for blocks of self-contained residential flats which my client rents out. I initially have gone down the Finance lease route, given the length of the lease term and as the 'risks and rewards of ownership' passes to my client for the lease term. Also my client must register the leases with the land registry and pay stamp duty on the leases. Having crunched the numbers as finance leases, it creates a £5.6m asset and liability, which is to be wound down over the 25 year lease term. This is very significant increase for this business (micro entity), which at it's last year end only had total assets of c£10k.
I have checked the balance sheet of some of my client's competitors and they have treated these 25 year leases as operating leases. This has questioned my own approach. I feel like treating it as a finance lease artificially inflates the balance sheet and, given the way the numbers work, at the next year end the lease liabiltiy will be c£200k greater than the lease asset. Here is some examples of the finance lease criteria that has not been met:
- the lessor does not transfer ownership of the asset to the lessee at the end of the lease term
- gains or losses from fluctuations in the fair value of the residual fall to the lessee
- the lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent
- the lease term is for the major part of the economic life of the asset (debatble)
The criteria that has been met includes:
- at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset
- property title is transferred on land registry (this makes the decision feel like a no brainer).
Do you agree with my initial assumption that these leases should be treated as finance leases? Any opinions are welcome.