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HMRC internal manual

Business Leasing Manual

HM Revenue & Customs
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‘Income-into-capital’ schemes and back loaded leases: Introduction to 'income-into-capital' schemes: Chapter 3 of Part 21 of CTA 2010 - overview of accountancy treatment

The commercial accounts spread the lessor’s total ‘interest’ in the rentals over the lease period in proportion to the outstanding debt each year. It does not matter when the cash is actually paid, so long as it eventually comes in.

Example: suppose a lease lasts two years. At the start of Year 1 the lessor buys a piece of machinery or plant for £50m. The parties agree an interest rate of 10%. The rental payable in Year 1 is nil. The rental payable at the end of Year 2 is £60.5m. This consists of:

  • £50m capital repayment.
  • £5m interest for Year 1’ and
  • £5.5m interest for Year 2 (that is, £55m debt at the end of Year 1 @ 10%).

The accountancy measure of the lessor’s earnings is £5m for Year 1 and £5.5m for Year 2. Those are the figures in lessor’s commercial accounts. But for tax purposes - before FA97/Sch12 - there was arguably no income in Year 1 in the example above. The full £10.5m ‘interest’ in the rental was taxed in Year 2. The result sought was that while the total amount taxed was the same as the commercial measure, the tax comes in later - a timing loss for the Exchequer. Chapter 3 of Part 21 of CTA 2010 applies the commercial measure of the interest earnings for tax and eliminates any timing gain.