Finance Leasing Manual - FLM28.06
How the typical 'income-into-capital' 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 a property from the Borrower for £10 million.
- The Bank immediately leases the property 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 property 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:
a) repay the £10
million 'borrowed'; and
b) 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 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.
