Capital equipment: To lease or purchase?

It may be plant, machinery, office furniture, computer equipment, company vehicles or service equipment. Whatever the purchase, a company needs to decide whether to purchase the equipment outright, or whether it will finance the purchase.
Purchasing outright – the advantages:
_ The company has outright ownership of the asset.
_ As the owner, the company can claim a tax deduction for depreciation on that asset.  The depreciation allowance offsets the cost of capital assets against taxable profits.
_ The company is not committed to a long-term financing agreement.
_ The overall cost will be less than the total cost if the asset was financed.
Disadvantages:
_ The company has to outlay the full cost of the asset up front which will affect cash-flow.
_ If the company is operating on a bank overdraft this will add to the cost of the asset.
_ The company can’t easily spread the cost of the asset to match revenue coming into the business.
_ The asset will depreciate and soon be worth less than what was paid.
_ There will be another cash outlay required when the asset needs replacing.

Leasing is a popular option as it frees up working capital for use in other areas of a business. There are generally two types of lease arrangements: finance leases and operating leases.
An operating lease is usually preferred where the equipment is not needed for its entire working life. The leasing company will take the asset back at the end of the lease and is responsible for its maintenance and insurance. The asset is not shown on the balance sheet.
A finance lease is a long-term lease which typically covers the expected life of the equipment, and frequently has a minimum of three years. At the end of the lease, the company (“lessee”) pays a surrender value to purchase the asset because the leasing company (“lessor”) will not want to retain ownership of it.  The lessor recovers the full cost of the equipment, plus interest charges, over the term of the lease. The leased asset is shown on the lessee’s balance sheet as a capital item, as is the lease liability, and the lessee will be responsible for maintaining and insuring the equipment.
Leasing – the advantages:
_ There is no lump-sum payment up front; this conserves working capital.
_ Businesses do not have to set aside funds for purchasing machinery.
_ The funds not used to purchase equipment can be used as working capital or used in investments with higher returns than that of fixed assets.
_ Leasing may provide access to a higher standard of equipment, which may be too expensive to purchase outright.
_ The payment for the asset is spread over the fixed period of time that it will be used, which assists in preparing budget forecasts.
_ Leasing does not require substantial collateral security.
_ The interest rates on leases are usually fixed, which makes it easier to forecast cash-flow.
_ The cost can be spread over a longer period of time enabling a company to match payments to income.
_ The company can usually deduct the full cost of lease rentals as a deductible expense from taxable income.
_ If the asset has not been bought outright, it alleviates concerns about an overdraft facility being withdrawn at short notice, forcing early repayment.
_ Leasing may be more convenient if it enables the company to proceed with the purchase faster.
_ The technology of capital goods changes rapidly; if equipment needs to be upgraded, updated or replaced, it can usually be done by making an adjustment to regular payments rather than investing a lump sum up front.
Disadvantages:
_ There is no tax depreciation claim on the leased asset until it is purchased, which is usually at the end of the lease (although the rentals themselves are deductible).
_ There is sometimes a requirement to pay a deposit.
_ It may be more expensive because of the interest charged on the instalments.
_ The company may be locked into medium or long-term agreements, which may be difficult to terminate.
_ Multiple leasing agreements can be more complex to manage than buying outright and may add to additional administration and compliance.
_ There is no ownership of the asset, although it can usually be purchased at the end of the agreement.
The tax implications associated with a finance lease will be discussed in our next article on leasing.

This information is intended as a general guide only. Tax law is complex and professional advice should be taken before acting on the information provided.

Lynette Morris is a partner at KPMG Thailand.