Use not
Ownership
We humans have a fixation about
owning things! But paying cash uses up working capital
that could help the business grow. You even have to
pay the PST & GST up front! True the business can
claim the CCA but as we will show you the right
structure can outweigh that item. Owners tend to put
off replacements because of the heavy outlay of a cash
purchase...and so on. Business needs to use capital
assets not own them!
Creative
Structuring
Banks are primarily holders of short
term deposits and have an obligation to keep
themselves relatively liquid. Of course they invest in
term loans mortgages etc. Term loans are usually
provided on a prime + basis although some will fix.
Floating rate loans make little sense for capital
acquisitions. No one can predict money costs 3 - 5
years out! Equipment often does not get fully utilized
day one - more like a bell curve. Try that for a loan
structure!
A couple of years ago we worked with
a major leasing Co to structure a lease for a client
who was installing a major piece of equipment that
would take 6 months + to get set up. Normally the
rental would be fixed depending on money costs at the
time of completion of installation. Our Lessee wanted
to fix the rate NOW! No problem - not only did we
arrange the funds at today's rate we were able to
handle construction progress payments through an
agency agreement.
Payment structuring can tailor the
lease to your seasonal cash flow, accelerate, skip or
defer payments and so on.
Conserving
Working Capital
That one is simple! Of course a loan
will do that too - so long as the bank does not insist
on a demand note - which some accountants will deem
makes the loan a current liability (insist on a loan
agreement that evidences "demand" is only a distress
measure). Also a demand loan may indirectly restrict
capital available for operations if the bank gets
reticent about its total exposure when your expansion
(probably induced by the new equipment!) requires you
to request increased operating lines.
Not only does a lease conserve
working capital by covering the purchase cost - it
also allows you to pay PST & GST on the rentals rather
than up front. The right structure will defer income
taxes resulting in a further conservation.
Deferring
taxes
I
f
your lease rentals for the fiscal year exceed what you
could otherwise have claimed in CCA and interest then
your tax book profit will be less and more dollars are
retained for working capital.
You must look at the situation
throughout the lease term to get a true assessment. A
lease versus loan versus cash calculator comes in
handy for this. There are a number of financial
programs commercially available. Basically the
alternate cashflows must be present valued to get a
fair comparison.
Where the CCA rates are high ( i.e.
earth moving equipment or pollution prevention
equipment) the lease does not usually have a tax
advantage unless the term is very short. Some lessors
have more appetite for your CCA than you can use and
will pay for it with effectively lower implicit
interest rates.
For normal CCA classes (30% and
under) 3 - 5 year leases tend to provide a tax
deferring advantage. Structuring higher rentals in the
initial year so long as it is reasonable (as opposed
to artificial) can be an effective tool if the cash
flow can handle the higher payments.
Operating
Leases
To
be an operating lease it must comply with
CICA rules (see our summary table)
Basically these require that the present value of the
committed rentals be less than 90% of the cost of the
equipment and the term less than 75% of its economic
life. In other words the lessor must be at real risk
for 10% or more of that cost.
Most leases in Canada are written as
"stretch leases". That is the term is say 66 months
but the lessee can exercise an option to buy the
equipment for 10% of its original cost at the 60th
month. If the lessee does not he/she can buy it for
its fair market value at the 66th month or renew the
lease. This does not meet the operating lease test as
you can be sure the present value of the 10% option is
less than 10% at the outset of the lease therefore the
rents PV must be more than 90%. It is also fairly
obvious that the lessor is at no equipment risk if the
lessee fails to exercise the option. Accountants will
treat this as a Capital Lease (although Revenue Canada
will generally buy off on the rental expense claimed).
The equipment is recorded as a leased ASSET and the
lease as a lease LIABILITY. In an operating lease all
that the lessee records is the rental EXPENSE.
Some operating leases are simply
created by having (say in the above example) a lower
rental, longer term and a 25% option at 60 months -
the latter exercised by a Third Party. If the third
party is less than arm's length run it by your
accountant.
A few major leasing Cos have some
very sophisticated means of achieving an Operating
Lease while allowing lessee effective continued use of
the equipment. We have access to these.
Some equipment lends themselves to
Operating Leases readily because of their high
residual values which dealers or lessors or 3rd party
investors are happy to risk themselves on. Of course
these sometimes assume you are happy to "roll" the
equipment!
Keeping Bank Lines
Free
We sort of dealt with this one under
"Conserving Working Capital"
What can be Leased?
T
ypes
of assets that can be leased are extremely broad
though' each lessor has its own preferences
Preferred items include vehicles,
heavy equipment, machine tools, office equipment and
computers. The former have good resale values and are
easily disposed of in the case of repossession. Hence
the lessors dollar exposure is lessened. Office
equipment and computers permit the lessor to broaden
its industry exposure even though disposal values will
likely be in the 25 - 33 cents in the dollar range.
There is a limited availability of
funds for leasehold, software (5-6 figure packages)
fixtures etc. Your business must be a strong
profitable covenant to attract an approval. Most
leasing Cos won't touch these items even then. There
are a few who will however.
Disposables can not be leased. By
disposable we mean consumed in the ordinary course of
business
