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HMRC internal manual

Business Leasing Manual

Taxation of leases that are not long funding leases: net present value and calculating rents: lessor's timing advantage - finance lessor's approach

Finance lessors do not generally approach the analysis from the ‘present value’ direction. Generally, lessors will want to make a specified margin on their funds. For example, a lessor may decide that it wants to make an interest turn of 2% on the capital invested in its finance leases. So it feeds 2% into the computer program, together with other knowns - the cost of the asset (the ‘loan’), the cost of money, its likely expenses, the tax rates, the capital allowances rates, the rental payment dates etc - and out comes the rentals the lessor needs to charge to make a 2% turn. Although the starting point is different, the mathematics in the program relies on the time-value-of-money concepts previously outlined.

In practice lessors may depart from their theoretical target return or their target return may vary from sector to sector. They may charge more if the risk of default is greater or if the market will bear it. They may charge less if competition is fierce and they are trying to gain market share of if the lessee has a very high credit rating. Small ticket lessees are generally charged more than big ticket lessees (with small ticket lessees being charged a margin of several percent and big ticket lessees sometimes being charged a margin of 20 basis points (0.2%), or even less.

Lessors can also design rental profiles to suit the lessee. For example, often lessees want to match the profits from a new asset with the rental payments. So they want low or nil rentals when a major asset is being built (possibly over several years) and while production builds up. As the lessee’s profits begin to increase as the asset comes on stream the lessee can increasingly afford larger rentals. So they want a rental profile that rises over time (a ‘stepped’ rental profile).