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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Other tax rules on corporate finance: structured finance: the third relevant effect: example

Relevant effect 3: sale and leaseback or lease and leasebacks: potential restrictions of tax relief

Borrower has a freehold interest in land that it currently occupies for its trade. It grants a 51-year lease over the land to the finance provider for a premium of, say, £100 m.

The finance provider immediately grants a 5-year sublease to Borrower for payment of rent of £22.5m a year. The rent paid by Borrower will be sufficient to repay the £100m advance from the bank together with interest over the 5-year period. There will be an arrangement in place to ensure that all of the benefits of ownership will revert to Borrower at the end of 5 years.

In substance Borrower has borrowed £100m from the finance provider, which it repays plus interest over 5 years. But again the effect would be that the company would claim effective tax relief (for rent payable) for the repayment of £100m (equivalent to loan principal) as well as for £12.5m interest.

The conditions in section 758 are all met in relation to this scheme. In particular, the ‘lender’ is entitled under the arrangements to payments in respect of security. While the security disposed of is the headlease, whereas the payments received by the lender derive from the sublease, section 776 (2)(a) makes clear that payments in respect of any security include any value or benefit that the lender is able to obtain indirectly from that asset by for instance granting a sublease.

There is no relevant effect 1 or 2 as described by CFM73100 because in the absence of the scheme the borrower would not have received any rental income so is not escaping tax on any amount which it would have received apart from the arrangements. But there is a relevant effect 3 as described by CFM73110 because as a result of the arrangements the borrower becomes entitled to an income deduction. The legislation therefore provides that the arrangement shall not have that effect so the payer of the rents will not receive any rental deduction. However, as explained at CFM73030, the borrower will be able to claim an interest deduction in respect of the amount of finance charge shown in its accounts.

This particular scheme involving income from real property was countered by the rent factoring legislation in ICTA88/S43A to 43G that has now been repealed. Under those rules, the £100m premium received by Borrower would have been taxed as income in the period of receipt. The new legislation will instead ensure that Borrower will be taxed as if it had borrowed £100m with relief given only for the £12.5m finance charge.