To Lease or to Buy?

Every vineyard and winery owner must make equipment purchase decisions throughout the life cycle of their business. After selecting the equipment you need, the next step is to decide how you will finance the acquisition. If you are purchasing equipment for a new business, replacing obsolete machinery or looking to expand the scale or efficiency of your existing operation, you want to know whether buying or leasing would be the most advantageous approach for you..

More and more Canadian business owners are opting not to purchase new equipment at all. Instead, they are turning to leasing as an alternative. Under the right circumstances, leasing can prove to be a cost and tax efficient substitute for a purchase financed by term debt.

Randy Jones is President of Cellar Tek Supplies Limited, a supplier of winemaking equipment based out of Kelowna. His experience mirrors recent estimates that around 10% of business equipment is now lease financed. “Although most of our customers are using a combination of cash and traditional bank financing, we are definitely seeing more deals financed through third party lease arrangements. The ability to time payments to coincide with expected cash flows is a definite advantage for some.”

So how does leasing compare with a conventional loan arrangement?

With conventional loan financing, you become the owner of the asset. The bank loans you the funds to make the purchase under specified terms and conditions. The bank will typically register a security interest in the equipment as collateral and may require additional security. There is a specified rate of interest charged. For tax purposes, the purchaser can deduct the interest portion of the loan payments as well as annual depreciation charge called capital cost allowance (CCA). The amount of CCA allowed as a deduction is specified in the Income Tax Regulations depending on the type of equipment. The government is currently offering accelerated CCA rates on manufacturing equipment, such as winemaking equipment, as an incentive for new investment.

In contrast, when you lease equipment, the lessor retains ownership of the equipment. The lessee rents the equipment in exchange for specified payments over a defined period of time. There is no stated interest rate. Rather, an implicit rate of interest can be calculated by comparing the total of all lease payments to the fair market value of the equipment. For tax purposes, the lessee deducts the lease payments. There is no deduction for interest or CCA.

When does leasing make sense?

• When your business already has significant debt and balance sheet ratios must be maintained. Since you are not acquiring the equipment, there is no requirement to report an asset or a debt obligation on your balance sheet. Beware that some arrangements described as leases may actually be considered a financed purchase. Your accountant can advise you in this regard.
• Where no cash is available for a down payment.
• Where there is a good chance that the equipment will be obsolete in a relatively short period of time.
• When the allowable CCA rate of the equipment is low. If this is the case, a lease will offer a faster tax write off of your investment. As previously noted, the government has enacted accelerated CCA rates for eligible manufacturing equipment. For instance, winemaking equipment purchased prior to December 31, 2009 can be written off by 50% in 2009 with the balance deductible in 2010. This opportunity may sway the pendulum in favour of purchasing.

We have just presented a brief overview of factors to consider when deciding to lease or buy. The actual calculations can be quite complex and are best handled by your chartered accountant.