How Does An Operating Lease Work?
An operating lease can also be referred to as contract hire. Operating leases allow an asset (normally a vehicle) to be leased over a fixed term with an agreed annual kilometre usage for a set payment (rental). There is a residual value (balloon payment) at the end of the lease. This is an amount that is offset until the end of the term which has the effect of reducing your regular lease payments (rentals). The lessor (normally a bank or finance company) retains ownership of the asset while the lessee (you, the user) effectively just hires it for a period of time.
At the end of the lease period, you can choose to return the asset, continue the lease or purchase the asset. You are not liable for the residual value, the owners carry this risk. That means that you can simply hand the vehicle back at the end of the term and start again.
Operating leases are also available as fully maintained leases. With a fully maintained lease, your lease payment includes all scheduled servicing and maintenance costs, such as repairs, registration renewal and tyres.
The amount financed is GST exclusive. GST is charged on the lease payment and the residual value at the end of the lease. If you are registered for GST, you can generally claim some or all of the GST contained in the lease rental and the residual value as an Input Tax Credit on your next Business Activity Statement.
You can generally claim the lease payments as tax deductions if the amount financed is below the depreciation limit. If the amount financed is above the depreciation limit then you can claim interest charges on the lease and depreciation, up to the value of the depreciation limit. With an operating lease, the asset is not shown on your balance sheet.
Who Does An Operating Lease Suit?
An operating lease is suitable when the asset will be used predominantly (50%+) for business purposes. The product is mainly used by ABN holders – companies, sole traders, trusts and partnerships.
Operating Lease – Pros
Potential Tax Benefits – Under an operating lease GST is charged on the lease payment and the residual value at the end of the lease. If you are registered for GST, you can generally claim some or all of the GST contained in the lease rental and the residual value as an Input Tax Credit on your next Business Activity Statement. You can generally claim the lease payments as tax deductions if the amount financed is below the depreciation limit. If the amount financed is above the depreciation limit then you can claim interest charges on the lease and depreciation, up to the value of the depreciation limit. The asset is not shown on your balance sheet
No Capital Outlay – You can get the asset that you need for your business with zero or minimal outlay, so any capital that you do have can be used for other things.
Effective Cashflow – By financing the GST exclusive price and including a residual value (balloon payment) at the end of your lease this reduces your repayment and frees up more cash.
Inclusions – You can potentially include things like government fees, insurance premiums and accessories as part of your lease, so one repayment covers all of your costs.
Budgeting – You can opt to include all scheduled servicing and maintenance costs, such as repairs, registration renewal and tyres in your lease, which can assist you to budget costs more effectively.
Operating Lease – Cons
Security – Although using your asset as security can help to get you a lower interest rate it also means that if you don’t make your agreed payments you risk the asset being repossessed.
Personal Use – If you’re using the vehicle for predominantly personal purposes then an operating lease agreement is not the most effective option for you.
Asset Only – With an operating lease, the amount that you finance can only be used for the purpose of leasing the asset. You can’t split the funds and use part of the asset and part for something else.
Fees – If you opt for a fully maintained operating lease then there can be additional fees to pay for the administration of the maintenance costs.
Equity – There is little opportunity to build any equity in the asset as the main purpose of the product is to enable the user to simply hire the asset over a set period and then hand it back.
Charges – You may incur charges if you hand back the asset and you have exceeded your agreed kilometres or it is not in what the lessor regards to be a reasonable condition.
