When looking to upgrade equipment or acquire new buildings or grain storage, leasing is often presented as an option to traditional purchase financing.
Under a standard purchase, the purchaser takes ownership of the asset immediately. The vendor is paid in full, and if necessary, the purchaser can obtain financing from a lender who will likely only finance a portion (down payment or trade-in will be needed). The terms of this loan (payments, interest rate, amortization period) are negotiated between the lender and the purchaser.
Under a lease contract, the leasing company purchases and takes ownership of the asset. The vendor is paid by the leasing company. The lessee then agrees to use that asset for a set time period, for set lease payments paid to the leasing company over that time period. At the end of the lease term, the lessee usually has an option to purchase the asset from the leasing company for a pre-determined residual value.
When making a decision on how to finance new equipment purchases for your business, it is important to understand both the cash flow and tax implications of each option.
Cash Flow Considerations
A lease will often allow for much lower cash requirements up front, because a down payment/trade-in will not be required as is often needed for financing a purchase.
Annual cash flow requirements for financing a purchase would be the loan payments determined based on interest rate, amortization rate, and down payment provided.
Annual cash flow requirements for a lease will be the lease payments laid out in the agreement.
A comparison should be made between the annual cash outlays needed for financing a purchase vs annual lease payment. However, this comparison is best extended to look at the full term of the lease, taking into consideration the purchase option at the end of the lease, if the lessee is intending to take advantage of that option.
Tax Implications
The differences in tax treatment between a purchase and a lease option are as follows:
|
|
Purchase |
Lease |
|
Tax Deductions |
Purchase price is added to Undepreciated Capital Cost (UCC) balance for the applicable asset class and annual deduction is available for Capital cost allowance (CCA) based on total purchase price (half rate for first year) times prescribed rate for applicable asset class Deduction available for interest paid on loan payments made in the year |
Full deduction for lease payments made in the year |
|
Trade-in |
Trade in proceeds reduce the UCC pool for that asset class |
Trade in proceeds reduce the UCC pool for that asset class. Deduct as prepaid lease payment over term of the lease |
|
End of Term Purchase Option |
N/A |
Purchase option payment is added to UCC pool for that asset class (half rate CCA for first year) Capital cost for any future disposition, will include previously deducted lease payments. |
|
GST |
Input Tax Credits (ITC’s) claimed on purchase price in year of purchase |
ITCs claimed on each lease payment as paid |
The capital cost allowance rate for the particular asset class will greatly impact the above comparison. For example, the tax deduction for a lease payment on a grain storage bin will likely be much higher than the 10% Class 6 CCA deduction allowed for a purchased grain bin. However, if the purchase of a piece of equipment is being considered, the higher Class 8 CCA rate of 20%, or Class 10 rate of 30% (for vehicles and certain other motorized equipment) will allow for a larger annual deduction brining the comparison closer to the alternative annual lease payment deduction.
Other Considerations
Under a purchase, the purchaser is taking on the liability for any un-warrantied repairs and maintenance that may arise. Depending on the terms of the lease, these costs may be covered. As well, a lease arrangement may allow for access to newer equipment where these costs may not be as likely.
The lease payments are determined with an implicit interest rate component. It is important that this interest rate be disclosed in the lease agreement and taken into consideration when comparing against the option to purchase.
Careful consideration should also be given to any annual limits placed on kilometers or hours of use under a lease arrangement to determine if this limit fits within your specific business needs.
A lease may also allow for flexibility if there is any concern that the size of the operation may change in the future. For example, if a portion of a farm’s land base is leased, the level of equipment investment may need to remain flexible to allow for potential land base fluctuations.
Depending on the specific terms of the lease, leased equipment is not always disclosed on the lessee’s balance sheet. As such, the total equity reported in financial statements will be lower when equipment is leased rather than purchased. No equity is being built over the term of the lease.
Example of Lease vs. Buy Scenario
Tractor valued at $250,000
Loan Terms:
Interest rate – 3.25%
Amortization period – 5 years
Semi-annual payments - $27,288
Lease Terms:
Term – 5 years
Semi-annual payments - $25,000
End of term purchase option - $20,000
|
|
|
Cash Outlays |
Deductions for Tax |
||
|
|
|
Buy |
Lease |
Buy |
Lease |
|
Year 1 |
Loan payment |
54,576 |
7,748 |
||
|
Lease payment |
50,000 |
50,000 |
|||
|
CCA (Half year) |
37,500 |
||||
|
54,576 |
50,000 |
45,248 |
50,000 |
||
|
Year 2 |
Loan payment |
54,576 |
6,213 |
||
|
Lease Payment |
50,000 |
50,000 |
|||
|
CCA |
63,750 |
||||
|
54,576 |
50,000 |
69,963 |
50,000 |
||
|
Year 3 |
Loan payment |
54,576 |
4,629 |
||
|
Lease Payment |
50,000 |
50,000 |
|||
|
CCA |
44,625 |
||||
|
54,576 |
50,000 |
49,254 |
50,000 |
||
|
Year 4 |
Loan payment |
54,576 |
2,992 |
||
|
Lease payment |
50,000 |
50,000 |
|||
|
CCA |
31,238 |
||||
|
54,576 |
50,000 |
34,230 |
50,000 |
||
|
Year 5 |
Loan payment |
54,576 |
1,302 |
||
|
Lease payment |
50,000 |
50,000 |
|||
|
Buyout |
20,000 |
||||
|
CCA (Half-year for buyout) |
21,866 |
3,000 |
|||
|
54,576 |
70,000 |
23,168 |
53,000 |
||
|
|
|
|
|
||
|
|
5-year total |
272,880 |
270,000 |
221,863 |
253,000 |
Each particular scenario will arrive at different results depending on value of trade-in provided (if any), financing and lease terms provided, and capital cost allowance rate applicable. Additional CCA deductions may also be available if additions qualify for the Accelerated Investment Incentive (AIIP) or Immediate Expensing rules. NOTE - as of November 23, 2021, immediate expensing rules announced in the April 19, 2021 federal budget have not yet been legislated
If you want to know more about lease vs. buy considerations and how making the right choice could impact your business, contact Gregory Harriman & Associates LLP by email at This email address is being protected from spambots. You need JavaScript enabled to view it. or by phone at 1-403-934-3176.
Disclaimer
The information in this publication is current as of November 23, 2021.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact Gregory, Harriman & Associates LLP to discuss these matters in the context of your particular circumstances. Gregory, Harriman & Associates LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.