Taxation of leases: finance leases, operating leases and sale and leaseback

A haulage company needs ten trucks and cannot afford to buy them. It signs a three-year lease with a financier, pays a fixed rental every month and keeps the trucks running. Who owns the trucks for tax? Who claims the capital allowances? Does the company deduct the whole rental or only part of it, and does tax come off the rental before the financier is paid?

The answers depend on one question: is this a finance lease or an operating lease?

This topic covers the two classes of lease, the tax treatment for lessor and lessee (company income tax, withholding tax, value added tax and gains), capital allowances on leased assets under the Nigeria Tax Act (NTA) 2025, leasing as a regulated business, the International Financial Reporting Standard (IFRS) 16 rules and sale and leaseback. The previous topic covered the full company tax computation. The next covers non-resident taxation.

Key terms in plain English

Syllabus check

This topic is in syllabus area B (taxation of companies and investment income, 35% of marks). It covers:

• the concept of leases and the classes of lease: finance lease, operating lease, sub-leases and sale and leaseback;
• the tax implications for lessee and lessor, covering company income tax, withholding tax, value added tax, capital gains and capital allowances;
• leasing as a separate line of business and its regulation;
• recognition, measurement, presentation and disclosure of leases under IFRS 16;
• COVID-19 rent concessions, interest rate benchmark reform, a lessor’s forgiveness of lease payments, lease term and useful life of leasehold improvements, and lease liability in a sale and leaseback.

CAMA 2020 and leases

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

Finance lease and operating lease

A lease is a finance lease if it transfers substantially all the risks and rewards of ownership to the lessee. Any other lease is an operating lease. The judgement rests on the substance of the deal, not on its legal form. A finance lease usually has these features:

• ownership passes to the lessee at the end of the term;
• the lessee has an option to buy at a price so far below fair value that the option is reasonably certain to be used;
• the term covers a major part (about 80% or more) of the asset’s economic life;
• the present value of the minimum lease payments is substantially all of the fair value of the asset;
• the asset is so specialised that only the lessee can use it without major changes;
• the lease cannot be cancelled, and the lessee pays for insurance and maintenance.

Other forms:

• a three-party lease adds a lender who funds most of the price
• a sales-type lease is a finance lease granted by a manufacturer or dealer, who records a selling profit
• in a sub-lease the original lessee becomes lessor to a third party, and accounts for the head lease as lessee and the sub-lease as lessor
• in a sale and leaseback the owner sells the asset and leases it back

Tax: finance lease

Tax: operating lease

Capital allowances on leased assets

Until 31 December 2025, paragraph 18 of the Second Schedule to the Companies Income Tax Act gave allowances to a lessee under a finance lease and to a lessor under an operating lease. The NTA 2025 keeps the same split. Under Part 1 of the First Schedule:

• for an asset acquired under hire purchase or a finance lease, the qualifying expenditure in a basis period is the instalments paid by the hirer or lessee up to that period, excluding interest;
• the hirer or lessee is treated as the owner and claims the allowance; the person letting the asset cannot claim;
• where the owner leases an asset under an operating lease, the expenditure is treated as incurred for the owner’s own business, so the lessor claims.

Practical steps

List every lease, including vehicle and equipment leases longer than 12 months. Classify each as finance or operating for tax. Use lease software or a schedule to link rentals, ROU assets and lease liabilities. Keep a book-to-tax reconciliation, because the IFRS 16 depreciation on a ROU asset is not deductible and is added back. Review changes in the law and standards each year.

Leasing as a business

Leasing means letting movable property on hire, with or without an option to buy, where the lessor owns the property. It lets a business keep cash, spread cost, use newer equipment and scale up or down. It also improves ratios under older accounting. The main laws are the Equipment Leasing Act 2015, the Banks and Other Financial Institutions Act 2020 and the Central Bank of Nigeria (CBN) Revised Guidelines for Finance Companies. Key rules:

• only a limited liability company whose memorandum allows it, and that meets the Equipment Leasing Regulatory Authority (ELRA) rules, may carry on equipment leasing (s. 6);
• an equipment lease must be registered with ELRA within 14 days of commencement (three months for leases made before the Act); an unregistered lease is invalid between the parties and cannot be enforced against a third party acting in good faith and for value;
• the CBN licenses and regulates finance leasing; it does not regulate operating leases, but where one business does both and does not separate them, the CBN regulates the lot.

IFRS 16 in brief

The lessee recognises a ROU asset and a lease liability for almost every lease, measured at the present value of the lease payments, discounted at the rate implicit in the lease or, if that cannot be found, the lessee’s incremental borrowing rate.

The ROU asset is depreciated over the shorter of the lease term and its useful life, and the lease payments are split into finance cost and repayment of the liability. A lessee may instead expense payments on a straight-line basis for leases of 12 months or less (by class of asset) and for low-value assets (lease by lease). The lessor classifies each lease.

For a finance lease it records a receivable equal to the net investment and recognises finance income at a constant rate of return; for an operating lease it records rental income on a straight-line basis. The lease term is the non-cancellable period plus any extension the lessee is reasonably certain to use. Leasehold improvements are depreciated over the shorter of their useful life and the remaining lease term.

IFRS 16 does not apply to leases of mineral, oil and gas rights, biological assets, service concession arrangements, licences of intellectual property granted by a lessor or the licence rights in films, patents and copyrights.

Specific accounting issues

• COVID-19 rent concessions. A May 2020 amendment let a lessee skip the lease modification assessment where payments fell due on or before 30 June 2021, the revised consideration was substantially the same or less, and no other terms changed.
• Interest rate benchmark reform (Phase 2). A change to lease payments required by the reform, on an economically equivalent basis, is accounted for by updating the effective interest rate.
• Lessor’s forgiveness of payments. The lessor tests the operating lease receivable for expected credit losses under IFRS 9 before the concession, then re-measures the loss and derecognises the forgiven receivable on the date it is granted. The lessee records a gain for the amount forgiven.
• Sale and leaseback. If the transfer is a sale under IFRS 15, the seller-lessee measures the ROU asset at the proportion of the old carrying amount that relates to the right of use it keeps, and recognises a gain or loss only on the rights it passes to the buyer. If the price is not at fair value, adjust for a prepayment or extra financing. The September 2022 amendment says the seller-lessee measures the lease liability so that it records no gain or loss on the right of use it keeps; it applies from 1 January 2024. If the transfer is not a sale, the deal is a loan secured on the asset.

Worked examples

1. The term is 80% of the life of the machine.
2. The option is far below fair value, so exercise is reasonably certain.
3. The lease cannot be cancelled and the lessee bears the running costs.
4. Risks and rewards have passed to the lessee, so this is a finance lease.

1. WHT = 10% × 3,000,000 = ₦300,000, on the interest only.
2. The lessee pays the lessor 12,000,000 − 300,000 = ₦11,700,000 and remits the ₦300,000.
3. The lessor’s tax credit note is for ₦300,000.

1. Qualifying expenditure.
   6,000,000 − 1,000,000 = ₦5,000,000.
2. Annual allowance.
   20% × 5,000,000 = ₦1,000,000, claimed by the lessee.
   The lessor claims nothing.

1. VAT = 7.5% × 2,000,000 = ₦150,000.
   The invoice is ₦2,150,000.
2. WHT = 10% × 2,000,000 = ₦200,000, on the rental before VAT.
3. The lessee pays 2,150,000 − 200,000 = ₦1,950,000 and remits the WHT.
   From 2026 it claims the ₦150,000 as input VAT.

1. Proportion of the right of use kept.
   4,500,000 ÷ 18,000,000 = 25%.
2. ROU asset.
   25% × 10,000,000 = ₦2,500,000.
3. Total gain.
   18,000,000 − 10,000,000 = 8,000,000.
   Gain on rights transferred = 75% × 8,000,000 = ₦6,000,000.
4. Check: debits are cash 18,000,000 and ROU asset 2,500,000 = 20,500,000; credits are building 10,000,000, lease liability 4,500,000 and gain 6,000,000 = 20,500,000.

How to score full marks

• Classify the lease first and give the reason, because every later mark depends on it.
• Name who claims capital allowances and why.
• Apply WHT to the interest only for a finance lease and to the whole rental for an operating lease.
• Separate the pre-2026 and 2026 rules for VAT and gains when the question is dated.
• Show the sale and leaseback working in steps: proportion, ROU asset, gain.
• Link the answer to IFRS 16 and the relevant tax rule.

Common mistakes in the exam

• Letting the lessor claim allowances on a finance lease.
• Charging WHT on the whole finance lease rental.
• Including interest in the qualifying expenditure for allowances.
• Charging 10% capital gains tax for a disposal in 2026 or later.
• Capitalising input VAT into the cost of an asset from 2026.
• Recognising the whole gain in a sale and leaseback instead of the part on the rights transferred.

Quick revision

• Finance lease: lessee claims allowances; lessor taxed on interest; WHT on interest.
• Operating lease: lessor claims allowances; lessor taxed on whole rental; WHT and VAT on whole rental.
• Qualifying expenditure under a finance lease = instalments paid less interest.
• Equipment lease registered with ELRA within 14 days; only a limited liability company may lease.
• IFRS 16: ROU asset and lease liability, with 12-month and low-value exemptions.
• Sale and leaseback: gain only on rights transferred; amendment from 1 January 2024.
• CAMA 2020: ss. 222, 305, 308, 377(1), 378.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

Recent ICAN papers are written, although older papers such as May 2014 included multiple-choice questions. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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