Introduction: Commercial substance and structure: Finance leases: transferring risks and rewards
In the basic finance lease case most of the economic risks and rewards of ownership fall to the finance lessee although, as a matter of law, it is the lessor who owns the asset. As with any lease, the terms of the lease give the lessee the right to use the asset in return for the rental payments. However, finance leases usually contain provisions which ensure that the lessee can either
- continue to use the asset for very little payment after the ‘loan’ has been repaid and all the ‘interest’ has been paid (BLM00620), and/or
- require the lessor to sell the asset and pay most of the proceeds (after clearing the ‘capital’ and ‘interest’ debt) to them (the lessee) by way of a rental rebate (BLM00625).
As a consequence, if the asset is no good it is the lessee who suffers – they still have to pay all the rentals. Equally, if the asset is a great success and is worth more than expected when the ‘loan’ has all been repaid, it is also the lessee who reaps the benefit.