BLM30040 - Taxation of leases that are not long funding leases: tax advantages: examples comparing a loan and a finance lease, part 1 of 3

The following examples illustrate how the commercial and tax profits of each party are computed where a banker makes a loan with which a trader acquires machinery (Example 1) and where a finance lessor buys similar machinery and finance leases it to the trader (Example 2).

Example 1

A banker lends £1,000 to a trader for five years and

• the loan is repayable over the five years in the same way as a repayment mortgage,
• the trader uses the loan to buy £1,000 of machinery which is worthless at the end of the loan term,
• £200 worth of interest is charged on the £1,000 loan; this represents an interest rate of around 8% on the declining loan balance,
• £180 of expenses are payable by the bank, including interest payable of £160 on money the bank borrowed to fund the loan; this represents an interest rate of around 6.4%.

Example 2

A finance lessor buys similar kit for £1,000 and, in effect, makes a ‘loan’ to a traderon similar terms to those in Example 1. That is, the lessor

• finance leases the kit to the trader over a primary period of five years,
• the kit is worthless at the end of the lease,
• £200 of ‘interest’ is charged by the lessor, so that the total rentals payable by the lessee are £1,200,
• £180 of expenses are payable by the lessor, including £160 of interest on the money borrowed to fund the lease.