What is an Operating Lease?
An operating lease or Rental as they are sometimes called is a contract that allows for the use of an asset, but does not convey rights of ownership of the asset. An operating lease is not capitalised; it is accounted for as a rental expense in what is known as “off balance sheet financing”. In some cases you may make an offer to purchase the asset at the end of the lease but this is entirely at the discretion of the financier or lease provider.
Operating leases are typically used against assets with limited life spans such as computers, medical equipment and most other smaller equipment or machinery. They are also very popular for companies running large fleets of motor vehicles. This is a very good way to keep your equipment up to date without having to hold any residual liability.
In the case of motor vehicles you can have what is called a fully maintained operating lease that includes in the rental agreed services or running costs for the vehicle.
Tax and GST:
There are some tax advantages for taking out an operating lease such as claiming 100% of the repayments against business use but the leases have no claim against depreciation of the asset or purchase GST. GST is charged on the monthly lease rental and the residual value and can be claimed as an Input Tax Credit if used for business purposes.
By leasing a vehicle this way the financier or lessor is responsible for payment of the GST on the purchase price of the item meaning a lower initial finance amount and the customer only pays GST on the residual or agreed amount payable to purchase the vehicle at the end of the term.
Cost of Finance:
Operating leases are usually a little more expensive than traditional forms of finance due to the fact the financier or lease provider takes on the entire residual risk for sale of the asset when it is handed back.
Note: There are typically fair wear and tear guidelines with an operating lease.