BLM71010 - 鈥業ncome-into-capital鈥� schemes and back loaded leases: 'Income-into-capital' schemes: how the typical scheme works

The guidance that follows describes the lender in the scheme as 鈥榯he Bank鈥� for short, but it is usually subsidiaries of banks which 鈥榣end鈥� the money via a finance lease. Non-banking groups flush with cash could also use the scheme. The mechanics have been over-simplified to illustrate the principles.

At the outset the parties agree the steps as follows:

  • The Bank buys an asset from the Borrower for 拢10 million.
  • The Bank immediately leases the asset back to the Borrower for (say) 20 years on finance lease terms. The rents in the early years are less than a normal finance lease rent; the payments in later years are correspondingly larger.
  • The Borrower never ceases to have full use of the asset.
  • The Borrower has an option to buy the asset back at the ten year point for a lump sum of 拢26 million. Sometimes there will be several options exercisable over the term of the lease.
  • The price the Borrower pays to get the property back under any of the options is calculated at the outset to be the amount needed to:
    1. repay the 拢10 million 鈥榖orrowed鈥�; and
  2. give the Bank a commercial rate of interest for the ten year period (allowing for the modest rent paid); for illustrative purposes assume that no rent is paid and that the interest rate is 10% (which compounds to 拢16 million of accrued interest after ten years).
  • If the option is not exercised, the lease rentals will rise so that they are sufficient to repay the 鈥榣oan鈥� capital and the 鈥榠nterest鈥� over the rest of the lease.

The avoidance lies in the fact that the option price paid for the asset (拢26 million) takes the form of a capital sum. The 拢16 million 鈥榠nterest鈥� element in that sum is a capital gain but it is designed to be covered by indexation or other capital gains reliefs and so, in practice, escapes all taxation.

This example uses a lease with a term of 20 years which may typically have been the case before FA 2006. Following FA 2006 a finance lease of more than 5 (or sometimes 7) years is a long funding lease unless the lease is of a ship to a tonnage tax company. Also from 9 October 2007 the finance lease in a sale and finance leaseback will normally be a long funding lease whatever the length of that lease (CAA01/70I(10)).