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HMRC internal manual

Business Leasing Manual

’Income-into-capital’ schemes and back loaded leases: 'Income-into-capital' schemes: Purchase options: variations

The general idea behind the option is to return the asset to the Borrower group or pass it to the Borrower (where the Borrower didn’t previously hold it, as where the Bank buys a new office block from a builder etc). However, the asset may be transferred in a variety of ways. All achieve the same economic effect but the legal mechanisms are different. Some examples are listed below and, no doubt, there are others.

  • The interest acquired when the option is exercised may be simply the original interest Borrower sold or granted to Bank; this variation declined in popularity as tax planners became more aggressive and exploited the alternatives below which are more tax-efficient (because they enable Bank to avoid capital allowances balancing adjustments on the disposal of the original interest).
  • Suppose Bank obtained a 31 year lease from Borrower on assignment at the outset (Lease A) and granted a 30 year lease back to Borrower (Lease B). When the ‘loan’ is repaid Bank arranges for Borrower to acquire an interest in over-riding Lease B; for example, a 30 year (less one day) lease at a peppercorn. Borrower then has the over-riding lease and is an intermediate landlord; future rents due under Lease B are now paid by one Borrower company to another; Lease A now has no value to Bank and could be transferred to Borrower for a nominal sum.
  • The parties may vary the terms of the original leaseback from Bank to Borrower. For example, they may agree to commute future rents payable under the original lease from Bank to Borrower to a nominal sum on payment of a lump sum from Borrower to Bank. Suppose at the outset Bank had bought the freehold from Borrower and then granted Borrower a 999 year leaseback. Here the future rents due to Bank after the option date are reduced to a peppercorn; that leaves Borrower with the full economic benefit of the original freehold interest without any material rental commitments. There will usually be a further option which lets Borrower acquire the now worthless freehold for a nominal sum; the freehold is worthless because it yields no income for 999 years.
  • The parties may vary the terms of any other interest, so that rents which continue to be payable by Borrower to Bank under the original lease but are effectively returned to Borrower. Suppose, for example, Borrower originally granted a long lease to Bank for a capital sum (the ‘loan’) and that lease provided that Bank paid low rentals to Borrower. Here the option might be that those low rentals are increased so as to match the rents Borrower has to pay to Bank under the sub-lease Bank granted back to Borrower.
  • Borrower may acquire control of the lessor of the subsidiary interest; that is, the Bank’s lessor company is a special purpose 100% subsidiary which only leases the asset to Borrower. For example, the ‘loan’ is repaid with the remaining interest in the form of a payment to the lessor’s parent for all the shares in the lessor.