Finance Leasing Manual - FLM6.07

Lessor's timing advantages can be significant

For the small sums in the example at FLM5.17 the lessor's timing gains are trivial. But consider the implications for an investment in kit (perhaps power generating sets) costing £100 million instead of £1,000. Both lessor and lender would then pay tax of £700,000 on the deals if all the figures were adjusted proportionately. But the 'net present value' of the tax repayments and payments for each are, assuming (a) a 10% interest rate and (b) a 5% interest rate:

• finance lessor: (a) £213,000 (b) £417,000;

• lender: (a) £538,000 (b) £594,000.

In other words, because the lessor has the use of the upfront tax repayment and pays its tax later, the 'net present value' ('real' cost) to it of the tax is substantially less than it is for the bank. In case (a) the real cost for finance lessor is £325,000 less than it is for the bank (£538,000 less £213,000). In case (b) the saving is £177,000.

These timing gains are significant when you consider that, on a £100m loan over five years, the pre-tax commercial profit is only £700,000 for both lessor and lender. The advantage of finance leasing over lending is therefore found by comparing the 'net present value' of all the cash flows (positive and negative) on a loan with all the cash flows (positive and negative) on an equivalent finance lease. The advantage varies with the length of the primary period, the profile of lease rental payments (level, front-loaded or back-loaded), the rate of tax, the rate of tax relief on the capital expenditure and the rate of interest. See FLM6.14 for an explanation of the meaning of 'net present value'.