The definition of a finance lease can be difficult to pin down. In legal form a finance lease is just another lease - the legal ownership of the asset lies with the lessor and the lessee only has the right to use the asset.
However, in commercial terms a finance lease is often considered to be an alternative form of 'purchase' with a loan of money and with the asset as security. In substance the finance lessee buys the asset with a loan from the finance lessor.
It is important to be able to distinguish what type of lease is in place, i.e. whether the lease is actually an operating lease (usually a type of rental agreement) or whether it is a type of purchase agreement, usually known as a finance lease. There can be important differences between the accounting and tax treatment of different types of leases.
HMRC’s internal manual defines a finance lease as follows:
To put it another way, a finance lease may be viewed as an arrangement under which one person (the lessor) provides the money to buy an asset which is used by another (the lessee) in return for an interest charge. The lessor has security because they own the asset. The terms of the leasing arrangements aim to give the lessor a banker’s interest turn and no more or less - however good or bad the asset proves to be for the end user.