Business equipment is a critical most organisations, but purchasing equipment can be a significant expense, and there’s where equipment finance comes in.
Nowadays, as companies are squeezed for resources and cash, with increasing interest rates and banks tightening their credit policies, many are considering their options around equipment finance and asking themselves whether they should lease or buy equipment.
One of the ways to conserve capital is to not buy outright the income-generating equipment your business uses. By financing your equipment purchases, you may not have that immediate drain on cash reserves that can be slow to rebuild.
Equipment finance comes in various shapes and sizes and can be tailored to your individual business needs. There are pros and cons to each arrangement and only you can make the final decision on what is best for you, based on the advice from your accountant and tax and legal advisers.
Renting Business Equipment
When capital expenditure is not a business advantage, or your equipment needs to be updated often, or it’s more important to use the equipment than own it, then an Operating Lease or Finance Lease may make sense for you. Likewise, when buying expensive equipment or machinery, paying upfront can have a serious impact on your cash flow, only to own an item that may depreciate faster than you can rebuild your cash reserves.
When you rent or lease your equipment, you may be able to take the strain off your cash flow, the rental payments may be tax-deductible to you and, best of all, you can have access to the most modern equipment or technology without the worry about how to dispose of the equipment when you’re done with it.
If that fits what your business needs, then what solutions are available to you?
*Operating Lease. An Operating Lease is an agreement to rent equipment for use in a business for a fixed period. Upon maturity you simply return the equipment to the financier subject to return conditions.
As it is the financier who takes responsibility for the disposal of the equipment at the end of term, and the customer has no obligation to buy the equipment, the customer has no risk of being left with old equipment. It can be a cost-effective financing strategy if you are continually upgrading equipment or if you are only interested in the use of the equipment rather than ownership.
Benefits of an operating lease include:
-Off balance sheet funding: rental payments can generally be treated as an operating expense and may be 100 percent tax-deductible.
-Flexible end-of-term options: you can simply hand back the equipment in the agreed return condition with no further obligations. If you want to continue using the equipment after the end of term, you may be able to request to continue renting the equipment or make an offer to purchase the equipment.
*Finance Lease. Under a Finance Lease, the financier owns the asset and rents it to the customer for a fixed term. At the end of that term, the customer guarantees the value of the equipment at the end of term (this value is called the residual value). Should the equipment be returned and sold for less than the residual value, the customer will need to make up any shortfall. The agreed residual value needs to be commercially realistic and should reflect what the equipment will be worth at end of term. The Australian Tax Office has set guidelines to assist with determining the minimum residual values required according to the effective life of the equipment (Taxation Ruling IT28).
Because the financier owns the asset, the asset is financed exclusive of GST and repayments (called rentals) may be fully tax-deductible. Each rental attracts GST and stamp duty but the cost is fixed over the term of the lease.
Benefits of a finance lease include:
-Up to 100 percent financing so your working capital is preserved
-Lease payments may be able to be claimed as a tax deduction
Buying Business Equipment
If your aim is to ultimately own the equipment or vehicle you wish to hire, you may want the following options.
*Commercial Hire Purchase (CHP)
A CHP is an agreement to purchase equipment when the customer’s aim is to ultimately take ownership of the goods at the end of the term and upon final payment.
Because of this, CHP contracts have far greater flexibility available in their structure than do leases. They may have structured residual values built into the last repayment (called balloons) or may be fully amortised. Payment structures that account for seasonal income periods may also be used.
The full payment under a CHP may not be tax-deductible; however the interest component of the payment and tax depreciation may be able to be claimed as tax deductions by the customer.
The GST paid on the asset may be claimable up front, but only if the customer uses the accrual accounting method. If the cash accounting method is used, the customer may claim 1/11th of the principal component of each installment in the period the payment is made.
Benefits of a commercial hire purchase include:
-Equipment can be purchased at any time during the term of the agreement
-The interest component of the repayments, and the depreciation on the equipment may be able to be claimed as tax deductions.
This is a loan agreement whereby the customer owns the equipment and the financier takes a charge over the equipment.
With this product, the financed asset belongs to the customer from day one. There is no legal ownership transfer between financier and customer. Instead, the financier takes a security over the asset and registers that security with the appropriate authority. A deposit may be made or the asset purchase can be 100 percent financed with flexible repayment terms with or without a balloon payment at the end of the term. Fixed principal and interest payments can be structured to meet peak income periods and interest is charged on the reducing balance.
Benefits of chattel mortgage include:
-Structure your payments to maximise your cash flow: monthly, quarterly, semi-annually, annually or other personalised timeframes.
-GST can be claimed immediately on the purchase price of the asset. This can mean a large cash injection back into the business around BAS lodgement time.
-Like the CHP, interest paid and depreciation may be tax-deductible.
-There may be no need for a deposit or a balloon.
Here we have identified a number of different ways you can preserve capital by financing equipment purchases. Before making a decision on whether to finance your equipment needs, we recommend that you seek independent advice from your financial, taxation and legal advisers to determine which products best suit your needs.
This article has been developed to provide you with an overview of equipment financing solutions. It is not intended to be advice, whether legal, tax or accounting, and does not take into account your personal circumstances.
—Michael Partis is a commercial sales leader for Wizard Business Finance, part of Wizard Home Loans Pty Ltd, and offers a variety of business finance solutions, including equipment finance, to SMEs. Wizard Equipment Finance credit provided by GE Commercial Pty Ltd.