BLM71010 - Schedule 12 FA 1997:
'income-into-capital' schemes: how the typical scheme works
The guidance that follows describes the lender in the scheme
as 'the Bank' for short, but it is usually subsidiaries of banks
which 'lend' 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 £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 £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:
- repay the £10 million 'borrowed'; and
- 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 £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 'loan'
capital and the 'interest' over the rest of the lease.
The avoidance lies in the fact that the option price paid for
the asset (£26 million) takes the form of a capital sum. The
£16 million 'interest' 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.
