Motor Vehicle and Business Equipment Finance

Phone: (02) 9890-9799 Fax: (02) 9890-9431
Email: adrian@aldersfinance.com.au

Finance Leases

Finance leases have been used for many years to finance motor vehicles, office equipment and machinery. Under a lease agreement the finance company (the lessor) owns the equipment and grants you (the lessee) use of the equipment & rents or leases this equipment to you. A finance lease has a pre-determined value left outstanding to pay at the end of the agreement called a residual value. This residual value is a guarantee to the finance company that they will get this amount at the termination of the lease.

Notes on Finance Leases

Under a finance lease, the financier will pay for the asset 100% and rent the asset to you. You have no ownership in the asset so if you have paid a deposit at the car yard this deposit will be refunded to you. The financier has title to the equipment.
The financier calculates the finance on the GST exclusive amount of the purchase and then leases the equipment to you. GST is then levied on the instalments. This is generally the case (luxury cars a good example of an exception)
Residual Values at the end of the agreement attract GST
If you use the equipment for business purposes then the payments you make are generally tax deductible (to the extent of your business use)
Payments are fixed for the agreement so you know with certainty what your commitments are
Finance Lease liabilities are noted on the Balance Sheet of your accounts
If you wish to change the equipment you will need to pay the existing agreement out before you can start a new lease
The lessee guarantees that the lessor will get a pre-determined amount for the equipment at the end of the lease
You run the risk that the equipment becomes obsolete and you still have the residual liability

The main reason that a finance lease would be chosen is that the lessee is able to claim the instalments as a tax deduction for their business. If the equipment is used 100% for business then the instalment is usually 100% tax deductible. It is important to note the difference between a finance lease and an operating lease. An operating lease does not have a residual value. A finance lease does.

So how do we know how much is the residual value?

There are rules to consider when the residual value is set. There are a number of ways to set the residual value and this residual value should reflect what the equipment is commercially worth at the end of the lease. This can often be hard to estimate and many factors may change this value including technology advances, changes to attitudes towards 2nd hand cars, new tariffs taxes and so on. The Australian Tax Office has set guidelines for this purpose. You should consult with your accountant who can advise you of additional ways to set residual values suitable to your circumstances.

IT28 & Effective lives of depreciating assets

In order to give tax payers some level of certainty about being able to legitimately claim the instalments as tax deductions, the Australian Tax Office made a ruling on 06/07/1960 known as IT28. This taxation ruling concerned the leasing arrangements of plant & machinery. It was devised so that traders could operate without fear of legal argument from the ATO if they followed their procedure of leasing plant and machinery.

This ruling effectively sets out the minimum residual values that can be used in leasing transactions according to the effective life of the equipment. The ATO ruled via IT28 that you could rely on tax deductions from your leasing claims if you set the residual value following their guidelines.

The following table sets out the minimum residual values required according to the effective life of the equipment (Taxation Ruling IT28)...

Minimum Residual Values Table According to Effective Life

Finance Term (Years)

Effective Life
(Years)

1

2

3

4

5

2

37.50%

0.00%

0.00%

0.00%

0.00%

3

50.00%

25.00%

0.00%

0.00%

0.00%

4

56.25%

37.50%

18.75%

0.00%

0.00%

5

60.00%

45.00%

30.00%

15.00%

0.00%

6

62.50%

50.00%

37.50%

25.00%

12.50%

7

64.29%

53.57%

42.86%

32.14%

21.43%

8

65.63%

56.25%

46.88%

37.50%

28.13%

9

66.67%

58.33%

50.00%

41.67%

33.33%

10

67.50%

60.00%

52.50%

45.00%

37.50%

11

68.18%

61.36%

54.55%

47.73%

40.91%

12

68.75%

62.50%

56.25%

50.00%

43.75%

15

70.00%

65.00%

60.00%

55.00%

50.00%

20

71.25%

67.50%

63.75%

60.00%

56.25%

For example if a depreciating asset had an effective life of 10 years then the minimum residual value set after 4 years would be 45% of the original cost. A telephone PABX system is such an asset that is deemed to have an effective life of 10 years.

One of the problems concerning a finance lease is that many lessors are reluctant to lease long effective life equipment to the lessee. This is for 2 reasons. Firstly often the equipment does not hold its value and secondly most financiers prefer the borrower to owe little or nothing at the end of the finance term to reduce the financiers risk in the transaction. This is why a finance lease for equipment that has a long effective life is often unworkable.

The ATO reviews these effective lives from time to time and TR 2008/4 was applicable from 01/07/2008. This can be useful to find out what the effective life is according to the ATO. You can access this by following the following link:

ATO Equipment effective life

NOTE: On that page, click on the "Table B" link near the top (or click here) to get a list of Effective Lives (Asset Categories Table B as at 01 July 2008).

Some examples of equipment and effective life is tabled below:

Description of goods	Per TR2008/4 Effective life (yrs)
Motor Cars – General - < 9 Passengers	8
Light Commercial Vehicles (up to 3.5 tonnes)	12
Heavy Commercial Vehicles (over 3.5 tonnes)	15
Taxis	4
Forklifts	11
Computers	4
Laptop Computers	3
Telephone Systems (PABX)	10
Photocopiers	5
Formwork beams & props steel	10
Waste Storage & Disposal Bins	10