BLM30040 - Taxation of leases that are not long funding leases: tax advantages: examples comparing a loan and a finance lease, part 1 of 3

The following examples illustrate how the commercial and tax profits of each party are computed where a banker makes a loan with which a trader acquires machinery (Example 1) and where a finance lessor buys similar machinery and finance leases it to the trader (Example 2).

Example 1

A banker lends 拢1,000 to a trader for five years and

  • the loan is repayable over the five years in the same way as a repayment mortgage,
  • the trader uses the loan to buy 拢1,000 of machinery which is worthless at the end of the loan term,
  • 拢200 worth of interest is charged on the 拢1,000 loan; this represents an interest rate of around 8% on the declining loan balance,
  • 拢180 of expenses are payable by the bank, including interest payable of 拢160 on money the bank borrowed to fund the loan; this represents an interest rate of around 6.4%.

Example 2

A finance lessor buys similar kit for 拢1,000 and, in effect, makes a 鈥榣oan鈥� to a traderon similar terms to those in Example 1. That is, the lessor

  • finance leases the kit to the trader over a primary period of five years,
  • the kit is worthless at the end of the lease,
  • 拢200 of 鈥榠nterest鈥� is charged by the lessor, so that the total rentals payable by the lessee are 拢1,200,
  • 拢180 of expenses are payable by the lessor, including 拢160 of interest on the money borrowed to fund the lease.