Finance Leasing Manual - FLM27.17

Schedule 12 FA 1997: example of main principles

Suppose (a variation on the example at FLM26.12):

• there is a three year finance lease of a real property asset;

• the total rentals due are £900;

• the total interest element in those rents is £120;

• the total capital element in those rentals is £780;

• no rents at all were payable for the first three years;

• there is an option to pay off the 'loan' and 'interest' for a capital sum at the end of Year 3, but if the option is not taken up, there are level rentals for Years 4 to 8 which recover all the capital together with the outstanding 'interest';

• the lessor charges an interest rate of 12%.

The original 'loan' of £780 compounded at 12% interest for three years at annual rests produces a debt of £1,096 at the end of the three years. Ignoring the tax effects, this might be the lump sum the lessee has to pay to get the asset back. If the lessee does not pay, the rentals are calculated using the usual repayment mortgage principles as follows. (Because of rounding errors the figures don't always add up precisely).

Calculation

In Years 1 to 3 the commercial accounts show total 'interest' earnings of £316 (£94 + £105 + £117). But there are no actual cash receipts. This SSAP 21 'interest' is the amount taxed by Schedule 12 FA 1997.

If the lessee doesn't acquire the asset for £1,096 at the end of Year 3 it has to pay the 'total rent' of £1,520 shown for Years 4-8. The 'interest' in the rent for these five years is £424 (£132 + £111 +£88 + £62 + £33). This £424 includes 'interest' due for the first three years of the lease (£316) when no rentals were paid. Since Schedule 12 will tax that £316 in over those first three years there is a mechanism to reduce the amounts of actual rent taxable by the amounts previously taxed. This avoids a double charge.