- As opposed to Hire Purchase, if you take out a Lease arrangement, you will NOT own the equipment or asset at any time during the plan.
- A lease is a contractual agreement between a Lessee and a Lessor.
- The Lessor is the owner of the asset or equipment, which would be either the manufacturer or the independent finance company that has purchased the goods, and the Lessee is the company or person that wishes to rent the asset or equipment.
- With a lease, the Lessor (owner) would reclaim the VAT element on the purchase price of the goods, but VAT would be chargeable on the monthly repayments, as with any other service or hire, at the prevailing VAT applicable rate.
Period of Hire
The term of a lease is generally referred to as the ‘Primary Hire’ period. The lessee can choose the period of hire, which is usually between 2 and 5 years on a normal financial lease.
When the primary period is due to end, there may be an option to extend the lease by entering into the ‘Secondary Hire’ period. Each finance house has their own policies in dealing with the end of primary terms, but typically the goods can be either handed back to the lessor, or the lessee can pay an annual rent and continue to hire the goods for an agreed sum.
However, there are many names for different types of leases, and it is essential that you understand the type of lease that you are entering into. If you are unsure of what you are agreeing and entering into, expert advice should be sought from your accountants or lawyers before you enter into a lease.
The three main types are:
1. Financial Lease
2. Operating Lease
3. Sale & Lease Back
With a financial lease, the assets would be used by the lessee as though the goods were their own, i.e. they would have full control of the asset, and they must correctly insure and maintain the goods. The finance house would provide a monthly rental which would generally be on equal payments over the lease primary term. However, this would usually be based on the cost of the asset and an interest charge. From the lessees point of view, there is no capital and interest split, it is just a monthly charge for the use of the goods. Generally, there are no cancellation rights with a lease, and therefore the lessee is accountable for all of the payments due under the terms of the lease.
Years ago, goods that were leased and required an operator or came with maintenance provided were called Operating Leases. Operating leases can be popular with large organisations that require a fleet of vehicles on the road, want the latest technology, or use assets that are too expensive to purchase outright, such as aircrafts and ships. Payments on this type of lease are not calculated on the basis of the cost of the asset, and the lessor would not expect to cover their purchase costs from the lessee, because the term of the operating lease would generally be less than the economic life of the asset. The lessor would recover their costs by renewing a lease or selling the asset for its residual value. There is generally a cancellation option with an operating lease.
Sale & Leaseback/Equity Release/Refinance
A sale and leaseback occurs when a company owns an asset outright and sells it to another company then immediately rents it back. This may be referred to as ‘a re-finance’ or ‘equity release’. The lessee must receive cash from the sale of the asset and then make the repayments to the lessor in the same way as a financial lease to retain use of the goods or equipment. This is a fast and effective way for a business to generate capital which can be used as they see fit – it can be for working capital, to use as a deposit against a further purchase, or perhaps for the purchase of goods or equipment that are not attractive to finance.
Advantages of Leasing
VAT is only paid on the monthly rentals, not on the purchase price of the goods, thus making leasing more lenient on cash flow. The rentals are tax allowable.