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HMRC internal manual

Tonnage Tax Manual

Ship leasing: Defeased leasing: Outline

Concept of ‘defeasance’

Defeasance is a term applied to arrangements made by a borrower who sets assets aside to cover the liability.  In the context of leasing it is used where arrangements are put in place to remove the usual risk of a lessor that payments will not be made under the lease.

Thus, under a straightforward finance lease, the lessor provides the finance that the lessee needs to acquire an asset.  The lessor, as the owner of the asset, is entitled to claim capital allowances, and the tax benefit of these allowances is passed onto the lessee in the form of lower lease rentals.

However some finance leasing schemes do not involve the provision of new finance, and they are in substance no more than arrangements for the sale of the benefit of the capital allowances, with little or no risk to the lessor.  Such leases are said to have been ‘defeased’.  See also TTM10110.

Special rules for ships leased to tonnage tax companies

Tonnage tax companies cannot themselves claim capital allowances, and there are special rules (in FA00/SCH22/PART10) to prevent lessors claiming capital allowances if they have not provided the finance required to purchase the underlying asset.

No capital allowances are available if the lease is part of sale and lease-back arrangements, even if those arrangements do not involve defeasance, see TTM10200.

For new acquisitions, the special rules are intended to prevent allowances being given where there is:

  • ‘Cash defeasance’, whereby the proceeds of the financing arrangement finds its way back into the banking system (for instance by a defeasance payment being deposited in a bank account from which the lease rentals are paid), or
  • ‘Legal defeasance’, whereby a third party assumes all the rental obligations under the lease in return for a defeasance payment from the lessee.

However, ‘leveraged leasing’ is effectively permitted, i.e. the lessor may lay off (share) the risk with a third party (as long as the arrangements with that third party do not themselves involve defeasance).

How the special rules work

Defeasance schemes can take many forms, and so the rules work by denying capital allowances in cases where the arrangements remove the whole, or the greater part of the lessor’s non-compliance risk, (see TTM10110).

When considering the extent of the lessor’s non-compliance risk for this purpose, certain forms of security may be disregarded. These are known as ‘excepted forms of security’, (see TTM10120and TTM10130).


FA00/SCH22/PARA90 (defeased leasing) TTM17496
FA00/SCH22/PARA91 (excepted forms of security) TTM17501
FA00/SCH22/PARA92 (sale and lease-back arrangements) TTM17536
Meaning of defeased leasing TTM10110