Finance Leasing Manual - FLM6.29

'Loan' outstanding will vary because of capital allowances

One issue ignored earlier is that timing differences created by tax will usually alter the lessor or lender's own borrowing costs. And, because tax timing benefits are usually passed on, wholly or partly, to the lessee or borrower, the commercial and taxable profits of the lessor or borrower may change.

Example:

• A lessor buys kit costing £1m and immediately qualifies for a 100% first-year allowance.

• The corporation tax rate for the lessor is 33%.

• The lessor has to pay 10% for its finance and charges 11% to lessees.

• The lessor finance leases the kit for a primary period of 15 years.

The lessor will have to spend £1m when it buys the kit so it needs to borrow £1m at the outset on which it pays 10% interest. The lessor will in turn charge the lessee 11% on the £1m. If the kit is bought on the last day of the tax year, the lessor (or the group of which it is part) will get the cash benefit of the 100% first-year allowance (£330,000) nine months later. Ignoring other expenses and receipts, the lessor's borrowings will therefore reduce from £1m to £670,000 after nine months.

The actual reduction in the lessor's borrowings will obviously depend on the pattern of rental receipts and outgoings. But, in principle, the lessor's own interest costs will also reduce at the nine month point: the lessor can use the tax payment to pay off a similar amount of its own borrowings.