Do you need equipment for your business?
Chances are you’re thinking about financing or leasing it.
At law, there is a difference between:
- Leasing (or renting)
- Financing
- Hire purchase transactions
In this article, we will look only at leasing and rental. They are also called finance lease transactions.
What is leasing?
Leasing means renting equipment rather than buying it.
There is one main distinguishing feature of leases and hire purchase agreements. Under the terms of a lease, there is no intention by anybody that the lessee will acquire title to the equipment.
The purpose behind a lease is for the lessor, the owner of the equipment, to give the lessee, exclusive possession of the leased goods for the agreed period to use the equipment according to the terms of the lease.
There is at law no distinction between leasing or renting. The difference is only who commercially uses which term.
Generally, short-term arrangements are called rentals. Longer-term arrangements are called leases.
Renting a car at an airport for two days to meet customers is a typical example of a rental agreement. The term of these leases may be anything from a few hours to a few days or, a few weeks.
Lease agreements give the lessee exclusive possession of the leased equipment. This exclusive possession is for a significant part of the equipment’s expected life. These are called leases or chattel leases. They may be classified as either operating leases or finance leases.
Examples include leases of:
- Capital equipment by manufacturing or
- Other industrial enterprises and
- Leases of motor vehicles by companies or by individuals, in each case for a period of years
A typical lease situation
The business owner who is leasing the equipment is the lessee.
The bank or financial institution that is renting the equipment to you is the lessor. In a leasing transaction, the lessor owns the equipment at all times. If there is a default of the terms and conditions of the lease, the lessor can take possession of the leased goods. As such, a form of security is not needed by the lessor.
Sometimes a third party is involved in longer-term lease arrangements. In these situations, there is:
• The seller of the equipment
• A financial institutor
• The eventual lessee
The payment flows under a finance lease like the one in the diagram are as follows.
First, there is the lump sum payment by the lessor to get the equipment. Second, there will be a series of lease payments from the lessee to the lessor over the term of the lease. Finally, the lessee may pay the residual value to the lessor.
If you have a genuine lease, you can claim a tax deduction for the lease payments. However, if there is a hire-purchase agreement the payments are not tax- deductible. The transaction is treated as a purchase. Usually, the lessee will generally pay the residual value and retain the truck.
Uses of lease financing
For a lessee, a finance lease is, financially, the same as borrowing funds to buy the equipment. The lessee must pay rent and may choose to pay the residual value. These amounts are equal to installment payments of principal and interest. There will be a final lump sum or ‘balloon’ payment. Calculate the interest rate for the transaction and compare it to the cost of a loan to buy the equipment. The tax deduction for loan finance is the interest payments on the loan, not the capital. The tax deduction for lease finance is the entire lease payments. For tax purposes, make sure the lease doesn’t have a requirement to buy the equipment at the end of the lease.
It’s important to look at these options because they can be the tools of affordability to manage cash flow.
There may also be tax benefits or other reasons for financing or leasing equipment. A summary of the distinguishing features is in the table below.