What are the tax benefits of leasing?
Organisations will often find themselves in a situation where they need to decide between purchasing a new piece of equipment outright or leasing the equipment instead. But few companies completely understand the tax benefits of leasing a piece of equipment.
Despite the tightening of leasing regulations with the introduction of IFRS 16 on 1 January 2019, there are still tax benefits that lessors and lessees can leverage, including:
- Lessees can take advantage of capital allowances
- Lessors can cover interest costs, client upgrades, reduce taxes on defaulting clients, and deduct maintenance costs
These are not the only benefits to leasing however. Companies can take advantage of:
- Technological relevance
- Reduction of financial burden associated with purchasing
- Lower cost than a loan
- Only pay for equipment when you need it
- The right to terminate
- Less administration
- Lessor may provide replacement equipment when current equipment fails
Here’s a more detailed breakdown of these benefits.
Tax Benefits For Lessees And Lessors
We will explore each of these leasing tax benefits in more detail below.
Lessee tax benefits
Lessees are offered one major tax benefit when taking advantage of leasing.
Taking advantage of capital allowances
Capital allowances allow you to deduct a percentage of the costs associated with a piece of equipment from your taxable profits on an annual basis.
Capital allowances can be applied to outright purchase, hire purchase or under long funding leases. According to the HMRC, a lessee cannot claim capital allowances on a leasing agreement, but a lessor can. You can read up on the HMRC definitions of the different types of leases here to find out whether you qualify for capital allowances.
Lessor tax benefits
Lessors gain access to a number of tax benefits.
Reduce interest costs
Leasing out a new piece of equipment allows lessors to take a loan to cover the majority of the cost of the equipment, and then lease the equipment out. This allows the lessor to receive lease payments while simultaneously covering the interest payments of the loan.
Decreases taxes on defaulting clients
If a client defaults on their lease, the company can claim the loss of the income from the lease as a tax deduction. However, they are still able to lease the “reposed” equipment out to a new lessee in order to bring in additional income.
Claiming back on maintenance costs
Any costs incurred and associated with lease asset maintenance can be claimed back. This tax deduction is possible because the lessor is still the owner of the equipment, even if it is being used by another company.
In the event that a client requests an upgrade on older equipment, the lessor assuming they are able to accommodate such an upgrade can state the older equipment is no longer of standard and claim a tax deduction. Once the client has returned the older equipment, a company is able to claim additional tax deductions if they donate the older equipment.
Additional Leasing Benefits
The benefits of leasing extend beyond taxes. Here’s some of the other ways leasing can benefit your organisation.
Lessees can take advantage of the latest technology
Instead of investing large amounts of money in equipment that may be out of date before the equipment is paid off, the lessee can sign a lease for a fixed period and then upgrade or replace the equipment when the lease expires.
Avoid or limit the financial burden associated with purchasing equipment
Even if your company can afford to purchase a piece of equipment, this may not be the best approach from a financial perspective as it deducts from your working capital. A lease allows you to distribute the cost associated with the equipment over a longer period of time, without needing to worry about the difficulties of a loan. Not only are the costs of the equipment paid over a specific period of time, but these costs are offset by the income you generate while the item is in use. Additionally, companies can negotiate to pay the lessor through income generated by the leased piece of equipment at a later date or as benefits of use are realised.
Gain access to equipment at a lower cost than a loan
If you are looking for additional ways to reduce the impact on your bottom line, the costs are typically lower for leasing a piece of equipment than the costs associated with taking a loan and purchasing the equipment outright yourself.
Access to equipment when you need it
Some companies don't need access to specific equipment permanently, which is where leasing comes into play. For example, your company may need additional computers while working on a specific project for six months. If you know that you won't need those additional computers after the project, you can lease them for that six-month period. This will help your organisation save money since you no longer have to purchase the equipment for the project, only to have them sit and gather dust after the project is complete.
The right to terminate
At the end of a lease, the lessee is given the choice to continue use of the equipment at a reduced cost or end the lease. This gives the lessee the ability to assess whether the equipment is worthwhile taking economic ownership over, or if they need a different piece of equipment to handle the task. This kind of flexibility is not an option for organisations who purchase their equipment outright.
When you sign a lease, not only may you be reducing or removing the maintenance and purchase costs associated with equipment, you are reducing the administrative load on your organisation by transferring the majority of the administration responsibilities to the lessor.
Lessor is responsible in the event of a breakdown
In the event of complete equipment failure, depending on contractual terms the lessor may need to source replacement equipment for your organisation. This has two benefits: reducing the amount of downtime your company experiences while replacement equipment is sourced and reducing on the costs associated with replacing the equipment since the lessor is entirely responsible for the device.
These are the basics when it comes to the primary benefits of leasing. If you’d like to find out more about how leasing can benefit your organisation, take a look at our Ultimate Guide to Leasing and Lease Management.