If you are in business - equipment leasing or auto leasing are preferred means of acquiring the use of capital assets.
We humans have a fixation about owning things! But paying cash uses up working capital that could help the business grow. You even have to pay the PST & GST (or HST) up front! True the business can claim the CCA but as we will show you the right structure can outweigh that item. Owners tend to put off replacements because of the heavy outlay of a cash purchase...and so on. Business needs to use capital assets not own them!
Banks are primarily holders of short term deposits and have an obligation to keep themselves relatively liquid. Of course they invest in term loans mortgages etc. Term loans are usually provided on a prime + basis although some will fix. Floating rate loans make little sense for capital acquisitions. No one can predict money costs 3 - 5 years out! Equipment often does not get fully utilized day one - more like a bell curve. Try that for a loan structure!
A couple of years ago we worked with a major leasing Co to structure a lease for a client who was installing a major piece of equipment that would take 6 months + to get set up. Normally the rental would be fixed depending on money costs at the time of completion of installation. Our Lessee wanted to fix the rate NOW! No problem - not only did we arrange the funds at today's rate we were able to handle construction progress payments through an agency agreement.
Payment structuring can tailor the lease to your seasonal cash flow, accelerate, skip or defer payments and so on.
Conserving Working Capital
That one is simple! Of course a loan will do that too - so long as the bank does not insist on a demand note - which some accountants will deem makes the loan a current liability (insist on a loan agreement that evidences "demand" is only a distress measure). Also a demand loan may indirectly restrict capital available for operations if the bank gets reticent about its total exposure when your expansion (probably induced by the new equipment!) requires you to request increased operating lines.
Not only does a lease conserve working capital by covering the purchase cost - it also allows you to pay PST & GST (or HST) on the rentals rather than up front. The right structure will defer income taxes resulting in a further conservation.
If your lease rentals for the fiscal year exceed what you could otherwise have claimed in CCA and interest then your tax book profit will be less and more dollars are retained for working capital.
You must look at the situation throughout the lease term to get a true assessment. A lease versus loan versus cash calculator comes in handy for this. There are a number of financial programs commercially available. Basically the alternate cashflows must be present valued to get a fair comparison.
Where the CCA rates are high ( ie earth moving equipment or pollution prevention equipment) the lease does not usually have a tax advantage unless the term is very short. However the leasing Co may offer a cheaper rate to get access to that high CCA.
For normal CCA classes (30% and under) 3 - 5 year leases tend to provide a tax deferring advantage. Structuring higher rentals in the initial year so long as it is reasonable (as opposed to artificial) can be an effective tool if the cash flow can handle the higher payments.
To be an operating lease it must comply with CICA rules (see our summary table) Basically these require that the present value (calculated at your implicit borrowing rate) of the committed rentals be less than 90% of the cost of the equipment and the term less than 75% of its economic life. In other words the lessor must be at real risk for 10% or more of that cost.
Most leases in Canada are written as "stretch leases". That is the term is say 66 months but the lessee can exercise an option to buy the equipment for 10% of its original cost at the 60th month. If the lessee does not he/she can buy it for its fair market value at the 66th month or renew the lease. This does not meet the operating lease test as you can be sure the present value of the 10% option is less than 10% at the outset of the lease therefore the rents PV must be more than 90%. It is also fairly obvious that the lessor is at no equipment risk if the lessee fails to exercise the option. Accountants will treat this as a Capital Lease (although CRA (the tax people) will generally buy off on the rental expense claimed - there are some indications CRA will accept a lease as an expense simply because it is called a lease). The equipment is recorded as a leased ASSET and the lease as a lease LIABILITY. In an operating lease all that the lessee records is the rental EXPENSE.
Some operating leases are simply created by having (say in the above example) a lower rental, longer term and a 25% option at 60 months - the latter exercised by a Third Party. If the third party is less than arm's length run it by your accountant.
A few major leasing Cos have some very sophisticated means of achieving an Operating Lease while allowing lessee effective continued use of the equipment. We have access to these.
Some equipment lends itself to Operating Leases readily because of it's high residual values which dealers or lessors or 3rd party investors are happy to risk themselves on. Of course these sometimes assume you are happy to "roll" the equipment!
Keeping Bank Lines Free
We sort of dealt with this one under "Conserving Working Capital"
What can be Leased?
Types of assets that can be leased are extremely broad tho' each lessor has its own preferences
Preferred items include vehicles, heavy equipment, machine tools, office equipment and computers. The former have good resale values and are easily disposed of in the case of repossession. Hence the lessor's dollar exposure is lessened. Office equipment and computers permit the lessor to broaden its industry exposure even though disposal values will likely be in the 25 cents or less on the dollar range.
There is a limited availability of funds for leasehold, software (5-6 figure packages) fixtures etc. Your business must be a strong profitable covenant to attract an approval. Most leasing Cos won't touch these items even then. There are a few who will however and again we have access to these.
Disposables can not be leased. By disposable we mean consumed in the ordinary course of business.