RSM New Zealand

Business vehicles - lease or buy?

If you are considering buying a new vehicle for your business and require finance, you have a choice of two options: to lease or buy the new vehicle.

Business vehicles – lease or buy?

An operating lease will finance the use of a vehicle without transferring the ownership to you whereas under a finance lease (or hire purchase arrangement) you will take ownership of the vehicle.

Over the normal period of an operating lease or finance lease (usually 3 years) the overall cost of either option works out approximately equal when all cost factors are taken into account.

However, income tax, fringe benefit tax (FBT) and goods and services tax (GST) implications may differ, so it is important that you obtain professional tax and accounting advice prior to making a decision between the options.

What should you consider when comparing lease and buy options?

When making a decision to lease or buy a business vehicle you must consider your business financial situation and review your priorities. Some questions are:

  • Is having a new vehicle every three (or so) years important?
  • Do you travel a considerable distance in your vehicle each year (high mileage)?
  • Is ownership of the vehicle more important than low upfront costs and no deposit?
  • What will be the financial position of your business at the end of the finance period?
  • What are the projected cash flows for your business?
  • Is the vehicle intended purely for business use or will it also be used personally?

Operating Lease

An operating lease is a contract for the use of a vehicle for a fixed period, usually up to 45 months; the first payment is made in advance.  At the end of the lease period you return the car to the lessor.  Assuming the mileage is within the range set in the contract, there will be no further payments required from you. Essentially you have simply rented the vehicle. Operating leases can either be inclusive of full maintenance or exclusive of it.

Finance Leases

A finance lease is also a contract for the use of a vehicle for a fixed period.  However, some finance leases account for the likely value of the car at the end of the lease period (known as the ‘residual value’).

You can expect lower monthly payments for a finance lease with a residual value than you would pay for an operating lease.  Further, you can usually buy the vehicle for the residual value at the end of the lease period.

If the use of the vehicle is greater than normal then there is a chance that the vehicle will be worth less than the nominated residual value. In this case there might be an extra cost to you.

If you opt for this finance lease option, your payments are based on only a portion of a vehicle’s cost, effectively on the portion of the vehicle’s cost used for the duration of the lease.  You have the option of not paying an upfront deposit and your monthly payments are fully claimable as an expense.  You make your first payment at the time you sign the lease.

Implications of Buying or Leasing

Operating leases are often the preferred option for businesses for a number of reasons, particularly if you are short of cash upfront, but have good cash flow. Operating lease payments are also fully tax deductible as an operating expense and the fixed monthly cost can often be easier to budget within the business. Operating leases provide you with the option of upgrading your vehicle at the end of the lease term (or purchasing it outright for the residual cost in the case of a finance lease).

When you buy the vehicle, you pay for the total cost of a vehicle as well as having to budget for maintenance, insurance etc.  In addition you may also pay interest on finances provided to you.

For tax purposes we treat the vehicle as a fixed asset. The interest on the HP or finance loan is also tax deductible. Generally we find that the differences in the tax implications of leasing versus buying are minimal.

Once the HP or loan balance has been repaid, you will own the asset. Usually with vehicles the asset will be worth less than what you paid for it, however it will still have a value.  If at this point you want to upgrade to a newer vehicle you will have some equity that you can use as a deposit on a new vehicle.  Alternatively you could continue to use the vehicle debt free. You have to remember however that the age of the vehicle may mean that your repair costs may be higher

The vehicle may be used to secure any HP you take out to buy it.  If you sell before the end of the HP term you have to repay the balance of the HP.

GST on Leases

With an operating lease, the instalments are effectively rental payments. GST is charged on the full amount of each instalment and is claimable as an input in the relevant GST return.

With a finance lease GST is charged on the principal portion only (not on interest potion of payments). The timing of when GST inputs on finance leases can be claimed will depend on the specifics of the contract.

For hire purchase arrangements ownership is deemed to have transferred at the time of purchase, and GST is claimable in full for the vehicle at the time of purchase.

You should obtain professional tax advice to ensure that the correct GST treatment is applied and the necessary records to support your GST claim(s) are in order.

FBT

If a business vehicle is used for personal purposes (either by you or your employees), you need to consider whether you are liable for fringe-benefit tax (FBT).

Professional Tax Advice
It is important that you select the right option to suit your business requirements and cash flow budget. Please contact us for professional advice prior to finalising the transaction.

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Authors

Galina Bell
Tax Principal - Auckland