Just as a loan secured on an asset may be repaid over a term which is likely to be shorter than the useful economic life of the asset, so substantially all the rentals payable under a finance lease may be due over a similar period. That period is known as the `primary period' of the lease. Having effectively `paid for' the asset during the ‘primary period’, the lessee will usually insist on having the right to continue to lease it for a further `secondary' period (which will last for at least the life of the asset). Usually the secondary period rentals will be nominal amounts - the lessee has already `bought' the right to use the asset.
In addition, under the terms of most finance leases, at any time
from the end of the primary period (and sometimes from an earlier
point) the lessee is generally entitled to require the lessor to
sell the asset and pay the proceeds to the lessee by way of rental
rebate. The asset is, in substance, the lessee's property and so
the lessee wants the sale proceeds. However, the lessor is
sometimes entitled to retain a small proportion, say 5%, of the
proceeds. In addition to this retention the lessor is also entitled
to ensure that it recoups its capital investment, plus interest on
the outlay, either out of the sale proceeds or by way of a further
`termination rental' payable by the lessee.
The parties must be careful to avoid any provision in the
leasing arrangements that gives the lessee the right to acquire
legal ownership of the asset because, in that case, CAA01/S67 will
shift the title to machinery and plant capital allowances from
lessor to lessee (see CA29310 onwards).
The commercial circumstances of the parties, and sometimes tax considerations, will determine the profile of rentals in the primary period. While flat rate rentals are payable under the majority of finance leases there are many cases where the rental profile is skewed in some way.
The first or earliest rental payments may often be significantly greater than subsequent payments within the primary period. This is often the case where a finance leased asset is replaced by another under a new lease. The rental rebate due to the lessee under the old lease is used to satisfy, in whole or in part, the initial rental payable under the new lease.
Conversely, payments may increase over the primary period to reflect expected improvements in the lessee's financial position. Back-loaded leases were also a feature of ‘income-into-capital’ schemes, at which the anti-avoidance legislation in Part 1 of FA97/SCH12 was aimed. Guidance on FA97/SCH12 is in the Finance Leasing Manual at FLM27.01 onwards.
