The question of whether to lease or buy a vehicle is one of the most frequently asked questions. While the cheapest way to buy a vehicle is to pay cash, most buyers need some kind of financing package. An increasing number of consumers are choosing to lease rather than take out a loan, mostly because the monthly payments are lower.
In addition, where the equipment in question is a vehicle, more questions may arise -- for instance, whether to have an interest free company loan instead of a car allowance or a company car and having a car available that is used at least 90% in business.
Before the decision to lease or buy is made, however, a number of variables must be taken into account and compared. Sometimes, a lease and purchase contract for the same vehicle may not be comparable. It pays, however, to attempt this comparison and to heed the adage "Buyer Beware" .
The information to be considered is the manufacturer's list price, any trade ins, the contract term, down payment, interest charges and residual value, and, the tax implications. "Passenger Vehicles" are subject to their own tax restrictions.
This comparison is more difficult than it looks. When looking at leasing, consider the big picture. Analyze your cash flow, look at what you will be paying in lease costs and what tax it will save you. Total costs for leasing probably will be higher, and there are restrictions, such as kilometre limits and renegotiation fees to break the contract, that might surprise unwary lessees.
The question of whether to lease or to buy equipment is one of the most frequently asked questions of accountants. In this presentation, I will assume that by "lease" we mean a contract which will continue for at least a year, and not the temporary rental of equipment.
One-fifth of retail customers now lease their new vehicles, in the estimation of Toronto-based DesRosiers Automotive Consultants Inc., which expects the figure to continue to grow steadily. Retail and commercial leasing combined accounts for about 37% of the acquisitions in Canada.
The most obvious attraction to leasing is its ability to lower the monthly payment on the purchase of a new vehicle.
At its essence, leasing is a very simple concept. The lessee (you) contract to rent vehicle from a lessor for a specific period of time, for a specified monthly fee. Your responsibility is to maintain insurance on the equipment, maintain it in normal repair and maintenance. When you turn in the equipment, the lessors process it through their cleanup centre and may present you with a bill for any excess damage above what they consider normal wear and tear.
The key point to remember about leasing is it is nothing more than a long-term contract. As such, the consumer who negotiates the best deal possible is the consumer who is most able to understand the complex financial document. The key is to look at the finance terms of the bank versus the lease company.
There is little or no financial disclosure required by law. All the leasing company is required to do is to tell you the monthly payment. The classic problem is because there is no disclosure, the interest rate or the capital cost can be played with. It is up to the consumer to arm yourself with a thorough knowledge of how leasing works, making you better to spot the best deals.
To illustrate, consider this advertised 24-month Executive Lease Option for an Infiniti Q45 luxury sedan. The advertised monthly payment is $799, based on $10,270 down, cash or trade. No security deposit is required and freight and predealer inspection are included. You are required to pay licensing and taxes, and there is an optional buyback of $42,280.
A quick run through the calculator reveals that the cost of this leasing arrangement equals almost $71,726 ($10,270 down plus $19,176 (24 monthly payments) plus $42,280 (buyback). These numbers reach a total that is very close to the manufacturer's suggested retail price.
Isn't this curious? Add up the numbers and we find that no interest has been included. How can Infiniti offer you 24 months of interest free use of its top of the line luxury sedan?
The answer is that it doesn't. The interest cost is buried somewhere in those numbers. This is the "shell game" that some economists call leasing programs. Somebody has to pay for it, and usually it's going to be the consumer.
The three components that determine the monthly payment of any lease are the capital cost, the interest charges and the residual value. The capital cost is the price of the equipment, including options, as determined by the lessor.
The residual (or buyback) value of the equipment is the forecast market value of the equipment at the termination of the lease -- also determined by the lessor.
In all leases, the monthly payments are based on the difference between the capital cost and residual value. In the case of our Infiniti, an added wrinkle has been thrown in, in the form of the $10,270 down payment. That's included to further reduce the monthly payment -- that $799 a month. Lessors stress that they require no money down, but that just means higher monthly payments or a greater buyback value.
Please note that you, as the consumer, are not in control. You did not negotiate the capital cost, and, in fact, it isn't even shown, or is it legally required to be disclosed to you. Similarly, the interest rate is not disclosed. Finally, the buyback is disclosed, but it has also been determined by the lessor.
All of which stands in sharp contrast to the traditional consumer loan used to finance a vehicle purchase. Thus, it is very hard to evaluate leasing deals. A leasing company can play with any one of these variables to structure the deal in their favour and the consumer has no way of finding out.It's very important, however, to understand that there is no evidence to suggest that leasing companies are actively misleading or misinforming consumers. Many of the larger leasing companies actually disclose much more than what is required by law. In other words, most tend not to play games. However, lower monthly payments open up the game, which means its back to "Buyer Beware".
The tax implications of a lease/buy decision will depend on whether the lease is a true lease or a purchase agreement by another name. Revenue Canada has the authority to change the tax treatment of the lease, if it feels the lease more closely fits the criteria of one type of lease over the other.
For tax purposes, there are two types of leases: the operating lease and the capital lease.
Operating Lease
An operating lease is much like paying rent. There is no option at the end of the lease to buy or bargain, although you can buy the equipment at an estimated fair value.
For equipment other than vehicles, the entire lease payment may be deducted, pro-rated for any personal vs. business use.
Passenger vehicles have their own set of (complex) rules and restrictions. The types of motor vehicles which are subject to these rules are:
Any reimbursements or notional interest on refundable deposits must be deducted. If any GST input tax credits are taken on business property, then they will not also be included in the calculation.
Currently, Revenue Canada allows 24,000 kilometres a year as the ceiling for business mileage for which the lessee is not required to be accountable for personal and business use. Otherwise, the lease amount is subject to a pro-ration of business to total use.
Capital Lease
The capital lease is much like purchasing the equipment, but instead of borrowing from the bank, you borrow from the lease company. At the end of the term, you can buy out the equipment for a nominal sum. The tax treatment for a capital lease is exactly like a purchase. For leased equipment which is owned or subject to a capital lease, capital cost allowance and the interest portion of the lease payment is fully deductible.
Again, "passenger vehicles" are subject to certain restrictions. If you own or have a capital lease on the car you use for business, you are allowed a capital cost allowance (depreciation) on the total cost of the car, including provincial sales tax, to a maximum of $24,000 ($26,160).
Capital cost allowance is allowed at 30% on a declining balance basis, except for the first year when the allowance is 15%. So, if the car costs $35,000, you may only claim 15% of $27,840, or $4,176. In the second year, you may claim 30% of $23,664 ($27,840 less $4,176), which is $7,099, and so on. In the year in which the car is sold, there will be no assets at year end and no capital cost allowance can be calculated. However, one-half of the depreciation that would have been allowed in that year will be deductible, provided that during the year you acquire another car which costs more than $24,000 and you keep it beyond year end.
Where money has been borrowed to purchase an automobile, the interest cost for tax purposes (and before prorations) is limited to the lesser of interest actually paid or payable in the year (even for cash basis taxpayers), and $10 per day times the number of days in the taxation year in respect of which the interest was paid or payable.
Both the capital cost and interest allowance must also be calculated in relation to business versus personal use.
In order to prevent circumvention of the above rules through shared ownership of vehicles, the rules provide that where a vehicle is jointly owned or leased, the maximum deduction available to each participant in respect of capital cost allowance, interest or leasing costs is the proportion of the amount otherwise deductible that the fair market value of the participant's interest is of the collective fair market value of the interests of all participants.
When you are considering purchasing, look at the present value of the cash outflow in relation to the savings of the capital cost allowance and salvage value. That should give you an estimate of what is better for you. Often, it will depend on the rates you are getting at the leasing company versus the bank.
Many dealers and leasing companies are willing to negotiate, but you have to do your homework ahead of time to determine what, exactly, will be to your advantage. The best starting place is to determine exactly what vehicle, including options, you want, and shop around, both for leasing and buying. There are a multitude of leasing deals and factory rebate programs that are available. Get written deals, and ensure all the variables are spelled out. Then, probably with the help of your professional advisor, or the help of numerous software on the market, you can determine whether one of the options you have can save you money.
So, is it better to lease or buy? Certainly there is a tax advantage to leasing if the car is acquired at the beginning of the year. All the monthly payments are deductible for the company, while the depreciation claim on a purchase would be capped at 15%. But the table turns toward purchasing if the car is acquired toward the end of the year when all the actual depreciation would fit within the 15% limit.
As well, odds are leasing will get you a much more luxurious car within the tax limits, because of the $24,000 cap. $650 per month can get you a nice car.
Some non-tax reasons to consider as a starting point for determining whether a lease is in your interest are:
For "passenger vehicles", you may deduct the least of the following: the expense of the lease payments, $650 per month (plus GST and PST; or $754 per month, $709 if ITC's claimed), or the actual lease cost times $24,000 (plus GST/PST) divided by .85. Note that Revenue Canada takes the position that for leasing purposes the actual lease charges used in calculating limitations do not and never did include GST, PST and insurance amounts shown separately as an addition to leasing cost. This means that there is effectively a double counting of the tax amounts.