Lease or buy? And how does a lease work?

[KateCB]

We are considering upgrading some of our embroideyr machinery, but it is a large investment, and whilst we technically could afford to buy the machinery, have been advised to look at leasing it instead.....

In my mind, this is a 'hire' - you have to pay for it every month, if you have a bad month and the bank account is a little lacking, tough, you still have to pay for it.....its never yours, you just keep paying, and you pay for the servicing and parts as usual, so are you going to end up overpaying for it?

If its like a car, you can change it in 3 years, but you still end up paying a lump sum to 'keep the new payment manageable', so you pay to use it, pay to service it and pay to change it....and then start again? Am I talking myself out of leasing here?

Many people lease machinery, there MUST be a benefit somewhere???

Can anyone tell me what it is - have to come up with a plan/decision by Wednesday!!

 

[Spearmint]

Firstly, I ought to point out that I'm not an Accountant so you probably ought to check what I'm about to advise you of.

A company recently sent me a document which relates to your question and the bones of it, are as follows:-

The Benefits of Leasing
Leasing converts a large capital expenditure into small monthly payments. Hence the company has the profit-making equipment immediately and keeps their cash reserve available.

Rather than investing the precious cash reserves in depreciating assets, the company can use them to help increase profits.

Lease Rental is 100% Tax deductable

The main reason that the majority of companies lease rather than purchase equipment is that they use leasing as a method of reducing their tax bills. This is because lease rental is 100% tax deductible, meaning that all payments you make for your equipment are written off against your tax bill. For any profit making business, this means a substantial saving in real cost of acquiring equipment by lease rental. This could save you between 20-40% of your lease payments, depending on the rate of tax you pay.

Payments on qualifying leases are written off as direct operating expenses, rather than a debt or outstanding liability, thus reducing short term taxable income.

Any capital allowances are passed on to you, you can offset your rentals against taxable profits and you can also reclaim the VAT on your monthly payments.

This status as a rental as opposed to a liability on a companies balance sheet is something the banks like to see, which is why an operating lease can be attractive. For this reason, leasing is often referred to as ‘off balance sheet’ financing – a tremendous advantage to both large and small business’s.

Ownership at the end of the lease

Lease rental is just that, a rental agreement, Title of the goods remains with the Lessor, which means the equipment does not show on the companies balance sheet, therefore not needing to be depreciated over a fixed period.

The disadvantage of buying equipment outright
The disadvantage to buying equipment out-right, is that the capital invested becomes a depreciating asset. This is an asset whose value decreases overtime.

The total amount that assets have depreciated by during a reporting period is shown on the cash flow statement, and also makes up part of the expenses shown on the income statement. The amount that assets have depreciated to by the end date is shown on the balance sheet.

Minimal cash outlay
• Overcoming of budgetary limitations
• Avoidance of obsolescence
• Flexibility in payment terms and
equipment
• Conservation of the business’ working
capital
• Preservation of existing funding lines
• Tax benefits - each lease payment
(including large deposits) can be offset
fully against pre-tax profit
• Fast Application Turnaround
• 100% Financing

 

[arcon5]

I've never understood this lease a car as the whole fee is tax deductible compared to capital allowances, where okay you write off 20% per year (for most cars) but the rest of the balance gets put through the books when it is disposed off.

You need to work out its workable life and compare the costs over a lease.

The benefits of leasing are of course your cash flow isn't affected so badly. Also depends if it has any maintenance included, which obviously adds significant value.

 

[David Griffiths]

Leasing is essentially a way of borrowing money. Somebody else uses their cash to buy the kit amd then charges to use it. You could take the difference between the cash price and the total leasing cost as essentially being interest.

I suspect that most people who lease simply don't have the cash to invest.

Most sales pitches focus on a questionable claim that it's more tax efficient. In the case of purchase of plant and equipment I don't think that claim stands up at all because you can write off up to £250k in the year of purchase

The document quoted above is clearly a sales pitch for leasing and I'd take issue with it on a number of points. In fact if somebody used that to try to convince me to lease, they'd be out of the door in about five seconds. I'll pick up on just one point

The disadvantage to buying equipment out-right, is that the capital invested becomes a depreciating asset. This is an asset whose value decreases overtime.

A statement of the blindingly obvious, which isn't negated by leasing in any way shape or form. If you lease the asset, it will be decreasing in value for the lessor in exactly the same way. In fact, they may even load the leasing payments to cover themselves but in any event the leasing payments will cover the depreciation over the life of the asset anyway. Claptrap.

 

[businessfunding]

It is a very big topic - I will be happy to give (non-tax) advice by PM.

Some considerations:

Lease vs real cash:

You post indicates that you have sufficient liquid capital to buy machinery for real cash (ie without using any other form f borrowing). In this case the main consideration is 'opportunity cost' or, put simply, an you use that cash more effectively elsewhere? If the money is likely to it in the bank for the next 3 years earning tiny interest then frankly you should use it to buy machinery.

if you have expansion plans which will use cash for a greater ROI, then you should compare the real costs of cash. Also bear in mind that investment in new machinery often accompanies other factors of growth which can deplete your cash.

Lease vs other forms of credit:

There are different forms of lease - predominantly operating & finance lease these differ in several ways. about 90% of leases written are finance leases.

Historically there were significant tax benefits to leasing, though these have been hugely eroded. You will need a professional tax advisor for specific input as to which form of finance is best for you taking into account year ends, profitability and the annual allowances available through the lease period.

You should compare with HP or loan agreements.

I agree that the post by Spearmint is fairly low-grade selling, leaning heavily on past benefits.

 

[US_US_Taxes]

Well done to Spearmint for such as concise description. Not an accountant, are you sure - well done!!

The only thing I would get you to ask is "Who owns the asset at the end of the term". If the asset is yours then the assets is capitalised and depreciated over the term. If you simply give the asset back then you can claim the against your profit & loss.

Ownership will be in your contract (most times in small print). If you have a choice at the end of the period to own it or give it back you need to be clear and have an agreement up front the decision you are making. If you leave it open HMRC can claim that the asset is your and should be capitalised.

I hope this helps a little more.

 

[businessfunding]

Well done to Spearmint for such as concise description. Not an accountant, are you sure - well done!!

The only thing I would get you to ask is "Who owns the asset at the end of the term". If the asset is yours then the assets is capitalised and depreciated over the term. If you simply give the asset back then you can claim the against your profit & loss.

Ownership will be in your contract (most times in small print). If you have a choice at the end of the period to own it or give it back you need to be clear and have an agreement up front the decision you are making. If you leave it open HMRC can claim that the asset is your and should be capitalised.

I hope this helps a little more.

Whilst broadly true, there are often options at the end of a lease agreement which can include 'continued uninterrupted possession' (ie virtual ownership) for a nominal fee.

Typically a purchase based agreement will be clearly identified by use of the word purchase (hire purchase, lease purchase, contract purchase etc)

 

[US_US_Taxes]

Absolutley right Kickstartbm hence my comment about look into the contract as these terms will be expressed.

 

[businessfunding]

Those options won't typically feature in the contract but can be negotiated.

 

[US_US_Taxes]

[FONT='Verdana','sans-serif']You are right in most cases.[/FONT]
[FONT='Verdana','sans-serif'] [/FONT]
[FONT='Verdana','sans-serif']As I have worked in procurement departments I would always advise my clients to put these terms in place. Contracts can be amended but appreciate many companies say "These are the terms accept them or leave" but I would generally ask them to enter specific terms.[/FONT]
[FONT='Verdana','sans-serif'] [/FONT]
[FONT='Verdana','sans-serif']Great points you have made.[/FONT]

 

[KateCB]

Thanks for that - We do have cash available, but you are right - we may need it to finance a marketing campaign as we are growing, hence new machinery, and we hadn't thought of that

This machinery can last 30 years or more if looked after; the machinery we have now is between 5 and 25 years old and the 25 year old machine is the one that we are looking to replace - I am not sure how long 'leases' are, but i think that an option to purchase at the end of a lease term (or update?) would be handy.

Once again, thank you for the concise and thought provoking responses

 

[businessfunding]

Thanks for that - We do have cash available, but you are right - we may need it to finance a marketing campaign as we are growing, hence new machinery, and we hadn't thought of that

This machinery can last 30 years or more if looked after; the machinery we have now is between 5 and 25 years old and the 25 year old machine is the one that we are looking to replace - I am not sure how long 'leases' are, but i think that an option to purchase at the end of a lease term (or update?) would be handy.

Once again, thank you for the concise and thought provoking responses

Hi Kate

For long life assets I would generally recommend a hire purchase agreement (though to reiterate you might want to take independent tax advice)

Mark

 

[David Griffiths]

Hi Kate

For long life assets I would generally recommend a hire purchase agreement

I'd go along with that. If you lease, there is usually a primary rental period of say five years. After that, you pay a secondary rental. In some cases that's a nomnal figure, but in others it's as much as the primary rentals, which is a rip-off. Sometimes you have to give a full six months notice to terminate to avoid this charge.

With hire purchase, the assets become yours at the end of the period. A lease with an option to purchase is usually taxed in the same way as hire purchase

 

[Spearmint]

Well done to Spearmint for such as concise description. Not an accountant, are you sure - well done!!

You give me credit for more than I deserve! I merely omitted the references to the company that sent me the document and copied in what was relevant.

However, I believe it served its purpose, for it has triggered some good and interesting replies.

 

[arcon5]

Could you not approach a bank for a loan to buy the equipment? This will at least achieve the desired result without tying up cashflow

 

[businessfunding]

Could you not approach a bank for a loan to buy the equipment? This will at least achieve the desired result without tying up cashflow

It is much, much easier to set up an HP deal than a loan.

Also keeps your banking lines clear if you need money for cashflow.