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HMRC internal manual

Business Leasing Manual

From
HM Revenue & Customs
Updated
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‘Income-into-capital’ schemes and back loaded leases: Introduction to 'income-into-capital' schemes: worked example of main principles

Example

Suppose (a variation on the example at BLM70235):

  • there is a eight year finance lease (or a three year finance lease with a five year secondary period) of a real property asset,
  • the total rentals due are £900,
  • the total interest element in those rents is £120,
  • the total capital element in those rentals is £780,
  • no rents at all were payable for the first three years,
  • there is an option to pay off the ‘loan’ and ‘interest’ for a capital sum at the end of Year 3, but if the option is not taken up, there are level rentals for Years 4 to 8 which recover all the capital together with the outstanding ‘interest’, and
  • the lessor charges an interest rate of 12%.

The original ‘loan’ of £780 compounded at 12% interest for three years at annual rests produces a debt of £1,096 at the end of the three years. Ignoring the tax effects, this might be the lump sum the lessee has to pay to get the asset back. If the lessee does not pay, the rentals are calculated using the usual repayment mortgage principles as follows. (Because of rounding errors the figures don’t always add up precisely).

Years 1 2 3 4 5 6 7 8 Totals
                   
Total rent       304 304 304 304 304 1,520
Capital       172 193 216 242 271 1,095
Interest 94 105 117 132 111 88 62 33 740

In Years 1 to 3 the commercial accounts show total ‘interest’ earnings of £316 (£94 + £105 + £117). But there are no actual cash receipts. The ‘interest’ is the amount taxed by FA97/Sch 12.

If the lessee doesn’t acquire the asset for £1,096 at the end of Year 3 it has to pay the ‘total rent’ of £1,520 shown for Years 4-8. The ‘interest’ in the rent for these five years is £424 (£132 + £111 +£88 + £62 + £33). This £424 includes ‘interest’ due for the first three years of the lease (£316) when no rentals were paid. Since Part 21 of CTA 2010 will tax that £316 over those first three years there is a mechanism to reduce the amounts of actual rent taxable (in years 4 - 8) by the amounts previously taxed (in years 1 - 3). so avoiding a double charge.