Capital assets - would you be better off leasing than buying?

Capital assets: would you be better off leasing than buying?

Buy or lease

There are often compelling reasons for a business to lease rather than buy capital assets. Leasing arrangements are a form of finance in which an asset is acquired by a third party, usually a bank or finance company, and then leased to the end user for a predetermined period of time. This arrangement means the business never actually has title to the asset for the term of the lease, although it is allowed to use the asset during that time.

In operating leases the term of the lease will be up to three quarters of the operating life of the asset. Repayments will be geared to the cost of the asset spread over that time, plus a profit margin for the lessor. The lessee is usually responsible for all ancillary costs related to the asset - insurance and maintenance for example.

If the lease is for more than 75% of the asset's operating life, it is treated for tax purposes as a finance lease (similar to a hire purchase agreement), regardless of what the terms of the lease say. If at the conclusion of the lease the lessee may or must purchase the asset for an amount likely to be less than market value, this also makes the lease a finance lease.

Why would you choose to lease?

Leasing assets avoids making the large down payment often necessary for asset purchase
Leasing frees up company funds for other business outlays
Since lease payments are usually fixed amounts at regular intervals, it simplifies predicting the cash flow situation
Leasing may reduce the amount of debt on financial statements; if neither the asset nor the leasing costs show up on the business' balance sheet
Leasing gives a business greater flexibility for upgrades or improvements to equipment
And because leasing costs are tax deductible, taxable income is reduced

What you'll need to consider

The leasing company, not the business, gets the depreciation tax deduction benefit and the up-front GST claim
Leasing may be hard to get for new businesses that haven't yet developed a credit history
It can be difficult or very costly to end a lease before it has run its full term
Some leases come with a variable interest rate that can cause a significant increase in the amount of repayments if interest rates rise
Leases at fixed interest rates can become relatively expensive if interest rates fall

Is leasing right for your business?

The business never actually owns the asset during the term of the lease, and the total cost of the lease payments will almost always exceed the cost of the asset involved. Leasing can, however, be one way of getting access to expensive equipment without a huge upfront payment and allow enough time for the equipment to pay for itself as it makes money for the business.

Start by assessing the capital assets your business requires; then look at options for financing and acquisition. Many vendors offer leasing arrangements on competitive terms with banks and other sources of finance. Once you have these details, consider the relative taxation advantages of leasing versus buying. If you have a profitable business and want to reduce the drain on your capital reserves that would occur from purchasing the asset, leasing could well be the way to go.

For more information contact your RAN ONE business professionals at
Academy of Business Excellence Limited