TTM10100 - Ship leasing: Defeased leasing: Outline
Concept of ‘defeasance’
Defeasance is a term applied to arrangements made by a borrower who sets assets aside to cover the liability. In the context of leasing it is used where arrangements are put in place to remove the usual risk of a lessor that payments will not be made under the lease.
Thus, under a straightforward finance lease, the lessor provides the finance that the lessee needs to acquire an asset. The lessor, as the owner of the asset, is entitled to claim capital allowances, and the tax benefit of these allowances may be passed on to the lessee in the form of lower lease rentals. But some finance leasing schemes do not involve the provision of new finance, and they are in substance no more than arrangements for the sale of the benefit of the capital allowances, with little or no risk to the lessor. Such leases are said to have been ‘defeased’, which is further explained at CFM11170.
Special rules for ships leased to tonnage tax companies
Tonnage tax companies cannot themselves claim capital allowances, and there are special rules (in FA00/SCH22/PART10) to prevent lessors claiming capital allowances if they have not provided the finance required to purchase the underlying asset.
No capital allowances are available if the lease is part of sale and lease-back arrangements, even if those arrangements do not involve defeasance, see TTM10200.
For new acquisitions, the special rules are intended to prevent allowances being given where there is:
- ‘cash defeasance’, whereby the proceeds of the financing arrangement finds its way back into the banking system, for instance by a defeasance payment being deposited in a bank account from which the lease rentals are paid, or
- ‘legal defeasance’, whereby a third party assumes all the rental obligations under the lease in return for a defeasance payment from the lessee.
However, ‘leveraged leasing’ is effectively permitted, that is, the lessor may lay off (share) the risk with a third party, as long as the arrangements with the third party do not themselves involve defeasance.
How the special rules work
Defeasance schemes can take many forms, and so the rules work by denying capital allowances in cases where the arrangements remove the whole, or the greater part, of the lessor’s non-compliance risk, see TTM10110.
When considering the extent of the lessor’s non-compliance risk for this purpose, certain forms of security may be disregarded. These are known as ‘excepted forms of security’, see TTM10120 and TTM10130.
References
| FA00/SCH22/PARA90 (defeased leasing) | |
| FA00/SCH22/PARA91 (excepted forms of security) | TTM17501 |
| FA00/SCH22/PARA92 (sale and lease-back arrangements) | TTM17536 |
| Meaning of defeased leasing | TTM10110 |