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HMRC internal manual

Business Leasing Manual

‘Income-into-capital’ schemes and back loaded leases: Introduction to back-loaded leases: why avoidance

This Chapter explains the schemes which FA97/Sch 12 (now Part 21 of CTA 2010 for Corporation and Part 11A of ITA 2007 for Income Tax) was enacted to counter. These schemes mainly exploited the old Schedule A tax rules for income recognition [entitlement basis], whilst recognising the lessor’s interest earnings in the commercial accounts in the usual way. The schemes fell into two main categories:

  • straightforward back-loaded or stepped rental leases (in which tax was substantially deferred);
  • schemes which converted ‘income-into-capital’ (in which tax on some of the lessor’s investment return was avoided completely by arranging for the lessor’s interest to be paid as part of a capital sum liable, in principle, to a capital gains charge but in practice covered by indexation and other reliefs).

The straightforward back-loaded leases are dealt with in Chapter 3 Part 21 of CTA 2010 (previously Part II of Schedule 12, FA 1997). The ‘income-into-capital’ schemes are dealt with in Chapter 2 of Part 21.

There is a common thread to the approach of for both types of arrangement. The differences stem from differing commencement provisions and the need to deal with capital allowances in Chapters 2 cases.

In the straightforward back-loaded leases (negative depreciation leases, as they were sometimes known), the finance lessor wants to recognise for tax the gross rents (the ‘interest’ and ‘loan repayment’ elements) for the period for which they are payable in accordance with the lease, regardless of their treatment in their commercial accounts.

In the more aggressive ‘income-into-capital’ schemes the finance lessor also sought to avoid tax altogether on some of their ‘interest’ earnings and to escape capital allowances disposal adjustments. When part of the lessor’s return takes the form of a capital sum, the taxable earnings are always correspondingly smaller than the accounts earnings.

The provisions of Part 21 do not apply to long funding leases (BLM20000 onwards) and the income into capital aspects have been supplemented by new rules introduced in FA06, see BLM80000 onwards.