What are the pros and cons of leasing equipment?

This article first appeared on January 13th, 2011.

I have been looking into the option of leasing equipment for my business due to the high cost of the items I need.

What are the pros and cons of leasing and what should I do to get the best deal for my company?

There are numerous issues to consider before determining what sort of finance, be it leasing, hire purchase or another form of finance, is appropriate for your situation.

I have assumed that your circumstances are such that you do not have sufficient cashflow in your business to purchase the equipment, given that they are high cost items, and that your question is about leasing compared to other forms of finance.

Prior to discussing the differences with alternative finance options, it is important to note that with any purchase of equipment, a costbenefit analysis should be undertaken to ensure that the revenue generated from the equipment will provide an adequate return on investment.

Pros of leasing:

• GST – you only finance the GST exclusive cost (as lenderlessor claims the GST input tax credit). This means that you are financing a smaller amount and therefore the repayments and the interest will be less.

• Tax – on the basis that the equipment is 100% for business use, you can claim the full amount of the lease rental payments as tax deductions. This is simpler (administratively) than calculating the depreciation and interest claims, which is required under other forms of finance.

  If you are a small business or still under the STS (Simplified Tax System) you can prepay up to 13 months and claim a tax deduction up front. You might do this in June if you have a high taxable income in the current year.

• Balance sheetreporting – you are not required to take up the liability or debt of the asset in your balance sheet (assuming you are a small business and not defined as a reporting entity under the accounting standards).

• Fixed interestrepayments – the interest rate and repayments are fixed which provides ease of budgeting and cashflow management.  Also, in an environment of rising interest rates, fixing the rate is beneficial.

• Security – this is limited to the asset being leased and personal guarantees – ie. real property is not required.

Cons of leasing:

• GST – You may wish to fund the GST to create additional cashflow into your business. Hire purchase finance generally funds the GST component and you can then claim the GST input tax credit.

• Interest rate – the rate is generally higher than with loans secured by property.

• Early repayment penalties – generally apply (to leasing, hire purchase and chattel mortgages) so you do not have as much flexibility in repaying the loan as a principal and interest loan.

Finding the best deal:

• Shop around – check with different finance companies as to whether they are interested in financing the type of equipment you’re purchasing and what their indicative interest rate is and whether other costs such as establishment fees apply. We always ask for repayment amounts and the interest rate for the same term so you can easily compare.

• Homework – prepare a finance proposal where you set out specific details of the equipment, the terms of the finance and your business history and business case, including financials and tax returns for the last two years. A solid business case will assist in minimising the rate of interest applied as financiers will apply a risk margin.

• Brokersaccountant – finance brokers or your accountant can greatly assist you in sourcing the best interest rate/finance and collating all information for your application.

Other issues:

• Other finance options – include hire purchase, chattel mortgage and loan (principal and interest or interest only) secured against real property.

• Hire purchase (HP)/asset purchase – GST credit is generally claimed by the purchaser and a finance company generally funds the GST. You claim a deduction for interest and depreciation, the loan liability is taken up in the balance sheet. The asset is included in depreciation schedule and, compared to a lease, deductions are likely to be more in the early years and less in later years.

• Chattel mortgage – works in a similar way to a HP, except if you are on the cash basis for GST reporting, you can claim all GST credits up-front. The establishment fee is normally more than HPs.