The lease vs. buy decision:
Leasing an asset offers significant potential advantages over purchasing that same asset. It conserves working capital, liquidity and credit lines and offers 100% financing. A "true" lease (as more fully described below) offers "off balance sheet" treatment and is treated as a monthly expense. As a result, the entire lease payment is tax deductible. Because the lessor becomes the owner of the asset, it can depreciate that asset. These depreciation benefits allow that lessor to lower the lessee's monthly lease payments.
Outlined below are a few issues that may be factors in determining whether to purchase an asset with cash, borrow the funds to acquire the asset or lease that asset.
Pricing - Depending on the ultimate structure of the lease, it is very likely that the overall cost of leasing an asset may be less than the cost of borrowing funds to purchase that asset. Many first time leasing customers do not realize this until we have an opportunity to present our lease proposal. Even the largest, most financially sophisticated, corporations lease capital equipment (including rail cars, aircraft, marine vessels, machine tools, rolling stock, communications equipment, construction equipment, medical equipment, food processing equipment, etc.)
AMT - Alternative Minimum Tax: The basic concept of AMT is to ensure that all corporations pay a certain minimum amount of tax regardless of the fact that their tax obligation might be reduced below that amount by deductions such as accelerated depreciation. It was designed to address situations in which profitable corporations eliminated a substantial portion of their tax liability by deducting depreciation and other non-cash "expenses." In essence, because of AMT, it is possible for a company to generate more depreciation than it is permitted to deduct. In such situations, leasing may be an excellent option because the lessor would be able to take full advantage of the depreciation benefits and could pass these benefits along to the lessee in the form of lower lease payments. In addition, most true lease payments would still be a deductible expense. It is important to understand that not every lease fits this category. Our leasing professionals can assist our customers and their accountants in creating a lease structure which minimizes the impact of AMT.
Mid-Quarter Convention - 40% Rule: It is no longer possible to buy equipment on the last day of a fiscal year and receive depreciation benefits for a full (or even one half) year. The mid-quarter convention - 40% rule states that if an entity purchases more than 40% of its total capital expenditures in the last quarter of its fiscal year, then depreciation benefits for all assets acquired during that fiscal year must be recalculated using the mid-quarter (not half year) convention. The mid-quarter convention provides that the appropriate amount of depreciation available is dependant upon the quarter in which the asset was purchased. Violating the 40% rule may substantially reduce initial useable depreciation. Leasing assets could prove to be the ideal alternative.
Sales Tax - Leasing is sometimes used as a way to defer payment of sales tax. Sales tax is calculated on the base lease payment and included in the total monthly payment. This will make the initial expense of a purchase lower (in many states the sales tax rate is 7% - 10%).
Initial Cash Outlay - Normally, leasing involves a lower initial cash outlay than would ordinarily be required in a loan. The classic lease would require only the first and last months payments in advance, which is usually far less than a typical down payment of 10% - 25% of the cost of the asset. In addition, freight and installation costs can usually be financed within the lease structure.
Balance Sheet Item or Footnote - Equipment purchases often cause a company to be out of compliance with the ratios outlined in loan covenants (liquidity, debt-to-worth, etc.). In some kinds of leasing, neither the asset nor the corresponding liability are reflected on the company's balance sheet. The monthly lease expense is reflected solely on the income and cash flow statements. The lease obligation is described in a footnote to the company's financial statements.
Risk of Equipment Obsolescence - Companies in highly competitive environments often need the most technologically advanced equipment available and cannot afford to be burdened with out dated or obsolete equipment. Leasing transfers the risk of equipment obsolescence from the customer to the lessor. In addition, at the end of the lease term, the equipment can usually be returned to the lessor without penalty. As a result, the customer is then able to acquire new equipment which is faster and more efficient.
Source of information: First Star Capital 2008 @ http://www.firststarcapital.com/leasevsbuy.htm#1 |
