F14 In applying SSAP 21, the key question is whether the lease is a finance lease, ie one that "transfers substantially all the risks and rewards of ownership of an asset to the lessee."* One indication of this is given by comparing the present value of the minimum lease payments with the fair value of the asset (often referred to as the '90 per cent test'). However, in many cases such a numerical test will not be required. The principal risks and rewards of ownership in a leasing context are usually demand and residual value. Where substantially all of the risks and rewards associated with these lie with the purchaser, it will be clear, without performing any calculations, that the lease is a finance lease (ie that the property is an asset of the purchaser). Only where there is a sharing of risk will a 90 per cent test be required.
.............................................
* SSAP 21, paragraph 15
F15 Even where a 90 per cent test is used, it is important neither to apply this as the only test nor to apply a 90 per cent cut-off in a mechanistic way. The overriding principle is to establish whether the purchaser has substantially all of the risks and rewards of ownership.
F16 Where a 90 per cent test is used, the question arises what rate should be used to discount the minimum lease payments. The principles underlying SSAP 21 require a discount rate that relates only to the property. A rate based in some way on the return from the entire PFI contract may not be a suitable rate to use since it will include an allowance for the risk relating to the service element of the contract. Where the service element is perceived as being riskier, relative to the property, this will give rise to a rate that is too high. Since a prerequisite for using SSAP 21 is that the payments for the property have been separated from those for services, it will usually be possible to derive such a property-specific rate from the PFI contract. Where sufficient information is not available, the rate should be estimated by reference to the rate that would be expected on a similar lease ie a lease of a similar property in a similar location and for a similar term). The estimate of the rate should be reviewed together with (i) the present value of the lease payments, (ii) the assumed fair value of the property, and (iii) the assumed residual value, to ensure that all figures are reasonable and mutually consistent.
F17 In determining what are the minimum lease payments, regard should be had to what is likely to have a commercial effect in practice. It follows that the minimum lease payments will comprise the expected PFI payments for the property, less any amount for which there is genuine possibility of non-payment.
F18 A further factor to be taken into account is residual value risk. Where this risk both is significant and lies with the purchaser, it is normally evidence that the PFI contract in substance contains a finance lease and the property is an asset of the purchaser. An example is where the property has a material remaining useful economic life at the end of the PFI contract and is passed to the purchaser for a nominal or substantially fixed amount.