Having good quality equipment is essential to your construction company. You need the right tools to get jobs done on schedule, and up to your standards, but is it better to purchase that equipment or lease it?
The answer is, drumroll please......... it depends.
Not just on the particulars of any purchase or lease agreement you’re looking at, but also on the needs of you and your business. When deciding whether to purchase or lease equipment, here are a few factors to keep in mind:
Heavy machinery is often needed to complete a job, but the price tag associated with new (or new to you) equipment can be a big one.
There are some tax advantages to leasing equipment
In Canada, leasing equipment can come with some money-saving tax benefits due to the differences in how the CRA treats leases and loans when it comes to both GST and income tax.
GST
GST Input Tax Credits (GST ITCs) are the GST you paid on expenses for your business. Those can offset the GST you collect on your revenue, and thus reduce how much you have to remit to CRA.
If you purchase a piece of equipment, you can make one large GST ITC claim for the period in which the purchase was made. After that, even if you’re still paying off the loan used to make the purchase, you can’t claim any more GST ITCs.
When you lease a piece of equipment, however, you’ll pay a smaller amount of GST ITCs on every lease payment. And because most leases include an embedded interest equivalent, you generally pay more GST ITCs than on an equivalent loan. This means you get a continuous small amount of GST ITCs for every year you hold the lease instead of one larger amount upfront, but you might get more overall.
Income tax
The CRA also views leases and loans as different types of expenses.
A lease is considered an operating expense, which means you can deduct the entire leasing cost in the year you paid it.
Taking out a loan to purchase a piece of equipment, on the other hand, is considered a capital expense and you get a deduction for
The interest portion of the loan payment; and
A portion of the purchase price. The amount of the purchase price you can write off is called Capital Cost Allowance (CCA) and CRA has a prescribed rate of CCA for different types of equipment. This CCA class can be a significant factor in which of the two options is most beneficial.
Inflated interest rates could cancel out any tax savings
Because of these two tax-saving opportunities, there’s a common misconception that leasing is always better than purchasing. But a lease is only better if the interest rates for both leasing and purchasing a piece of equipment are the same. Financing a purchase at 5% is far better than leasing at 12%.
It can sometimes be difficult to work out exactly what a leasing company’s interest rates are. They might hide it in the fine print of your leasing agreement or have it “baked in”, meaning it’s embedded within the overall pricing.
Here at Reach, we’re able to do calculations to extract the embedded interest rate and advise you on what the best option for you and your business is. We’ll take into consideration the interest rates, tax advantages, and any other relevant factors so you know you’re protecting your bottom line.
Be aware of non-financial considerations when it comes to leasing vs buying
In the construction industry, some of your main priorities are having high margins and a good cash flow so you can get the most from your business. That’s why you may prioritize finding the most financially beneficial option when it comes to leasing or buying equipment. Still, there are some key non-financial considerations you can’t ignore, like:
Selling your business:
Ongoing leases can make the process of selling your business slightly more difficult. In this case, it’s easier to own a piece of equipment outright rather than go through the steps of having someone else take over a lease or, worse, have to buy out the lease as part of their purchase of your business. Buying out a lease means paying up, all at once, any remaining lease payments that would have been required to bring the lease to term. Embedded interest, GST, PST and all.
Demonstrating assets:
With Lease to Own agreements, the buyout for a piece of equipment is often so low that, even when you own it outright, it becomes what’s known as a “ghost asset.” This means its full value won’t show as an asset on your financial statements when they’re being looked over by a third party, like banks for financing purposes, purchasers, or potential partners. There are ways to account for the lease on your financial statements as an asset, but this requires a degree of expertise and may result in additional accounting costs.
Like with any business decision, there’s no hard and fast rule for everyone. That’s why having a financial expert and advisor on your team who can weigh out all the pros and cons of each decision is so helpful. Our mission at Reach is to help remove the financial load from your shoulders so you can get your balance back. Learn more about how we help you reach in, reach out, and reach up here.