BLM30615 - Taxation of leases that are not long funding leases: passing on the benefits: benefits passed on to lessee

Since lessors are normally driven by competition to pass on most of the benefits of any tax break, the reduction in the lessor’s interest costs (which is derived from the tax benefits) will be reflected from the outset in the calculation of the rentals charged to the lessee. A finance lessor may, therefore, make a smaller commercial profit than a lender if the average indebtedness of the lessor over the life of the lease is less than for a lender.

Example, suppose both the lessor and lender paid interest at 10% to borrow and charged 11% to lend. The turn is 1% and, where the finance lessor’s indebtedness is reduced by tax timing gains not available to the borrower, the lessor will earn its 1% on a smaller sum than the lender. So the lessor’s profit will be less than it would be for an equivalent lender who didn’t enjoy the same timing advantages and so was, as a result, borrowing and lending more.

In other words, the lower absolute profit taken by the finance lessor is, in part, what can give finance leasing its attraction. But because the lessor can offer cheaper terms than a lender it may do more business overall - hence making more profit than the lender.