Sometimes a business will choose to lease assets long-term instead of buying them outright. A finance lease will be used by business owners to get better financial terms or because they lack the necessary funding to complete the purchase outright. As such, whether or not using a finance lease is in your best interests depends on your specific circumstances. This article will outline what a finance lease is and what your key considerations should be before entering into one.
What is a Finance Lease?
A finance lease involves the lessor (a person or group who leases money to another, usually a finance company in these situations) purchasing an asset such as equipment or a vehicle and then leasing it to the lessee (a person who has a right to use the item being leased) for a specified amount of time.
As the lessor purchased the vehicle, they can claim the goods and services tax (GST) from the purchase price and the rental payments to exclude GST. The lessor will recover the purchase price of the asset plus interest through the rental payments made by the lessee.
At the end of the lease, the lessee has the option to buy the asset (often for a small amount or by completing the last rental payment).
How is a Finance Lease Different to an Operating Lease?
An operating lease differs from a finance lease in a few ways, including:
- the repayments will not cover the full value of the asset in question;
- the agreement itself will last for less than the asset’s useful life;
- at the end of an operating lease term, the lessee can return the equipment without any further obligations; and
- all the running costs of operating the asset are included in the lease. This is generally not the case for finance leases, leading to greater price fluctuation and administrative expenses.
Lastly, a lease can be considered a finance lease for accounting purposes if the lease agreement substantially transfers the risks and rewards incidental to ownership of the asset to the lessee. The asset will appear on the lessee’s balance sheet as an asset and their obligation to pay rentals.
Conversely, in an operating lease, the lessor takes on the risk of the asset. This type of lease is off the balance sheet and is treated as an operating expense deductible from profits.
Key Provisions in a Finance Lease
Before you sign a finance lease, you want to be sure of what you are getting yourself into. One of the key clauses to check is your obligation to pay rent. This clause will set out:
- how much the rent will be;
- whether it excludes GST;
- when it is payable;
- how interest is accrued; and
- what will happen if you default on your repayments.
It is essential to understand this clause, so you can be confident you will be able to make timely repayments.
Maintenance and Repair
In a finance lease, the lessor takes on the risk of the asset. Understanding the maintenance and repair clause will inform you of your obligations relating to the asset you are leasing.
This clause will say:
- who needs to pay to service and maintain the asset;
- how often it should be serviced;
- what the servicing includes; and
- who may carry out the maintenance and repair.
Given that assets leased under finance leases are often of great value, it is of critical importance to ensure the asset is insured. The insurance terms will outline who is responsible for making insurance arrangements and who should be nominated as the interested party on the insurance policies. If the lessee is responsible for obtaining insurance, it may also state what the insurance should cover.
Personal Property Securities Register
The finance lease may include a clause creating a security interest under the Personal Property Security Register (PPSR). This means that the grantor, which is usually the lessee, grants a security interest to the secured party (the lessor).
If the lessee becomes insolvent or if it is a corporation that goes into liquidation, the lessee will then be deemed to have surrendered the secured asset to the secured party, and they may sell it to satisfy payment.
Obtaining an asset through a finance lease could be an excellent way for your business to access expensive assets such as equipment or vehicles. It is vital to consider the payment terms and tax and accounting implications of a finance lease before entering into one. By doing this, you can be confident it is the right decision for your business. If you need help deciding whether a finance lease is right for you, contact LegalVision’s leasing lawyers on 1300 544 755 or fill out the form on this page.
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