BLM31215 - The tax benefits of operating leasing: the tax benefits of operating leasing: example, part 2 of 2

Example

Taking the simple example at BLM31210, in year 1 the lessor might pay interest of £2.5m (£50m at 5%). It will also be entitled to writing down allowances of £12.5m (£50m at 25%), therefore in year 1 it will make a tax loss of:

Entry	Amount
Gross rents receivable	£4.14m
Less interest payable	£2.50m
Gross profit	£1.64m
Less capital allowances	£12.50m
Tax loss	(£10.86m)

Assuming the ship was sold for £35m in year 10, then over the 10 years a very simple view of the tax position might look like:

Year	Rental income	Interest paid	WDAs (BC)	Tax profit (loss)	Tax paid (repaid)
1	4.14	2.50	12.50	(10.86)	(3.26)
2	4.14	2.44	9.38	(7.68)	(2.30)
3	4.14	2.38	7.03	(5.28)	(1.58)
4	4.14	2.32	5.27	(3.45)	(1.04)
5	4.14	2.25	3.96	(2.07)	(0.62)
6	4.14	2.18	2.97	(1.01)	(0.30)
7	4.14	2.10	2.22	(0.19)	(0.06)
8	4.14	2.02	1.67	0.45	0.13
9	4.14	1.94	1.25	0.95	0.28
10	4.14	1.85	(31.25)	33.54	10.06
Total	41.38	21.98	15.00	4.40	1.32

The total taxable profit of £4.40m is the difference between the interest paid (£26.38m– see BLM30210) and the assumed interest element of the lease rentals (£21.98m).

The tax-timing advantage is clear and is, in principle, very similar to that which arises on a finance lease. The value of that benefit will be factored into the lease rentals and the tax / rental model will become far more complex than shown here.

Incidentally, this simple model illustrates the benefits that would arise if the balancing charge was avoided in year 10 as around £10m in tax is payable in that year (following net tax savings of £8.74m).