If an asset is leased to a lessee under a finance lease agreement, then for tax purposes, the lessee is treated as the owner and the lease payments are treated as loan repayments made by the lessee.

A lease of an asset is considered as a financial lease if any of the following conditions are met:

1. The lease provides for transfer of ownership at the end of the lease period.

2. The lease period exceeds 75 percent of the useful life of the leased asset.

3. The estimated residual value of the leased asset at the end of the lease period is less than 20 percent of the asset's fair market value at the beginning of the lease period.

4. The present value of the minimum lease payments is equal to or exceeds 90 percent of the fair market value of the asset at the beginning of the lease period. This provision does not apply to a lease that commences during the last quarter of the asset's economic life.

5. The asset was custom-made for the lessee, which will be of no value or of little value to others at the end of the lease period.

For the purposes of this Article, the discount rate used to determine the present value of lease payments shall be the rate used by the Saudi Arabian Monetary Agency (SAMA).

For the purposes of this Article, the lease period includes any optional renewal periods.

Where the lessor was the owner of the asset before the start of the financial lease, then in addition to being treated as a loan transaction as specified under paragraph (1) of this Article, the transaction shall also be treated as a sale by the lessor and a purchase by the lessee.

A financial lease transaction is considered a purchase by the lessee with a loan from the lessor. Therefore, and since lease payments represent repayments of the loan, they shall not be considered book expenses for the tax year.

Since the lessee will be treated for tax purposes as the owner of the leased asset, the following shall apply:

1. The lessee, not the lessor, is entitled a deduction for depreciation for that asset.

2. A lease payment is divided into two components: Principal and loan charge. The principal at the commencement of the lease is the present value of the minimum payments to be made under the lease.

3. The portion of each payment that represents repayment of the principal loan amount shall be treated as a repayment of the loan, and may not be included in deductible expenses for tax purposes by the lessee. However, the portion representing loan charge shall be treated as income for the lessor and expense for the lessee.

4. If the lessor is the owner of the asset before the commencement of the financial lease, then in addition to being treated as a loan transaction in accordance with the provisions of this Article, the transaction shall be considered a sale by the lessor and a purchase by the lessee, taking into account thetax implications arising from both the sale and thepurchase for the seller and buyer respectively.