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Jeff Sawyer, CA, Partner
Wheat, Oats and Barley
April 2008
It seems like you can lease just about anything these days. For years, farmers have been leasing vehicles, tractors and combines. Now, lease agreements for items such as grain storage and grain handling equipment are becoming popular. Leases are often promoted based on the argument that they are more tax effective by expensing the lease payments immediately versus depreciating the cost of the equipment over time using the appropriate capital cost allowance (CCA) rate. Is this true? Each lease versus buy scenario is different and should be analyzed before making a decision based on assumed tax benefits alone. Let’s consider the following example that I have encountered with one of my clients:
The item to be purchased or leased is a $100,000 grain bin, with a term commencing January 2, 2008. The bin can be leased by paying $15,000 on January 2nd, followed by no payments until January 2nd, 2009, at which time quarterly payments of $6,071 commence, with the option to purchase the bin at month 66 (July 2, 2013) for $10,000. My client informed me at the time his lender would provide him with financing to purchase the grain bin at 6.5%. To achieve this, I will assume he makes the same $15,000 down payment and then makes quarterly payments of $4,626 for the same 66 month period. I am using a tax rate of 30%, the capital cost allowance rate for grain storage is 10%.
| |
Lease |
Buy |
| Year |
Payments |
Lease Expense |
CCA |
Tax Benefit |
Net Cash Outflow |
Payments |
Interest |
CCA |
Tax Benefit |
Net Cash Outflow |
| 2008 |
$15,000 |
$15,000 |
|
$4,500 |
$10,500 |
$28,879 |
$3,985 |
$5,000 |
$2,696 |
$26,184 |
| 2009 |
24,282 |
24,282 |
|
7,285 |
16,997 |
18,505 |
4,546 |
9,500 |
4,214 |
14,291 |
| 2010 |
24,282 |
24,282 |
|
7,285 |
16,997 |
18,505 |
3,617 |
8,550 |
3,650 |
14,855 |
| 2011 |
24,282 |
24,282 |
|
7,285 |
16,997 |
18,505 |
2,625 |
7,695 |
3,096 |
15,409 |
| 2012 |
24,282 |
24,282 |
|
7,285 |
16,997 |
18,505 |
1,567 |
6,926 |
2,548 |
15,957 |
| 2013 |
22,141 |
22,141 |
500 |
3,792 |
18,349 |
13,879 |
439 |
6,233 |
2,002 |
11,877 |
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| Totals |
$134,269 |
$124,269 |
$500 |
$37,431 |
$96,838 |
$116,778 |
$16,779 |
$43,903 |
$18,205 |
$98,573 |
Note that there is only a difference of $1,735 in the net cash outflow between leasing and buying however there is still $56,097 left to be depreciated if you were to purchase the grain bin originally versus only $9,500 left if you leased the grain bin. How is this possible? It all comes down to the lease rate, which may or may not be disclosed to you. When I enter the above lease payments and buyout in my trusty loan amortization software, I calculate a lease rate of 10.66% versus the 6.5% purchase financing rate available from my client’s lender. From a tax perspective, if the lease rate is comparable to the rate available from your lender, it is only a matter of timing of the tax deductions. Any difference in capital cost allowance versus lease expense is negligible. This analysis would vary by the CCA rate of the equipment involved or the tax rate used which may range from 16.5% for a corporation to 46.41% for a farmer in the top tax bracket (based on 2008 Ontario tax rates).
This analysis also assumes that the buyout at the end of the lease approximates the fair value of the grain bin at that time. Many leases have a buyout at the end of the lease for a nominal amount such as $1 or $10. These buyouts are known as bargain purchase options, and if the value of the leased asset materially exceeds the bargain purchase option, the Canada Revenue Agency (CRA) may consider that a portion of the lease payments were in reality, a payment for this option and would be reclassified as a capital expenditure. In such a case, a portion of the lease payments would be deductible, while a portion would be capitalized as the cost of the asset, which would defeat any perceived tax benefits of entering into a lease to begin with.
If your operation doesn’t necessarily warrant the investment in a certain piece of necessary equipment, what other options are there? It may be that you can rent the equipment from a nearby dealer, share ownership with family or a neighbor or hire a custom operator to do it for you. All these options work especially well when the piece of equipment is for an operation which is not time sensitive, such as primary tillage or manure handling. It takes a little more patience sharing a planter or combine when the sun is shining and it seems that everyone else is in the field while you sit idle, waiting for your turn. Hiring a custom operator works well when you don’t have the time or manpower to perform a certain operation. However, if sharing a piece of equipment, it is important to come up with a cost sharing agreement in advance that satisfies all parties.
If you are deciding whether to lease or buy property, here are four tips to consider:
- Calculate the rate implicit in the lease and compare it to the rate available from your lender for similar terms.
- Base your analysis on the assumption that you will buy the asset out at the end of the lease, (treating it as an alternative set of loan terms).
- Don’t let the tax treatment be your main decision criteria, look at it more from a cash flow perspective.
- Be aware of the CRA’s position on Bargain Purchase Options.
This material is general in nature and should not be relied upon to replace the requirement for specific professional advice.
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