A question all businesses face when they are looking to purchase new business equipment – should we lease or buy in terms of taxation? What’s the best plan of action, when it’s time to upgrade equipment?
Leasing your business equipment in Canada safeguards your capital, cuts red tape, allows for quick and easy upgrades — and offers significant savings at tax time.
Leases and loans are treated very differently by the CRA (Canada Revenue Agency). Two of the most significant differences are found in monthly payment deductions and how you claim Input Tax Credits. Some businesses will benefit from larger, short-term tax rebates and some will benefit more from smaller rebates over a longer period. Either way, leasing can help bring down your tax bill.
If you own the asset, you will deduct capital cost allowance (CCA) or depreciation for tax purposes. This is the percentage of the asset cost you deduct from taxable income each year. The maximum percentage of the asset cost that is allowed to be deducted through CCA is dependent on the type or class of asset that was purchased. If bank financing is used to finance the purchase, only the portion of the payments relating to interest is tax-deductible. If you lease the asset, regardless of whether it is classified as an operating lease or capital lease for accounting purposes, the lease payments (principal and interest) are tax-deductible, as Canada Revenue Agency does not differentiate between an operating lease or capital lease.
If you own the asset, depending on the asset class for tax purposes, the first few years (other than the first year with the half-year rule), may provide a larger tax deduction than later years, as the cost base decreases over time while the lease payments remain consistent.
Two leasing-specific deductions that deliver valuable tax savings for your business.
When you make an equipment purchase (with bank financing or as a cash sale) you pay the full amount of Sales Tax (GST/HST/PST) due on that purchase at the time of the sale. Your business will then claim one large ITC on the purchase in that tax year. No further ITCs can be claimed on the purchase in subsequent tax years – even if your business is still paying down the loan. Note that if your bankrolls the Sales Tax into the loan amount, this benefit is usually eliminated.
If you lease the same piece of equipment, you do not pay the Sales Tax upfront, but instead, pay a small amount on each monthly lease payment. This means that each year you continue to hold the lease you can claim an ITC on the Sales Tax portion of the lease cost. It can also mean paying less tax overall if you upgrade or trade-in equipment before the end of the lease, as you will only have paid taxes on the equipment for the time you used it.
If you take out a bank loan for equipment purchase, you will be able to claim a deduction for the interest portion of your loan payment.
If the equipment is leased, CRA lets you deduct your entire lease payments for the year on your year-end tax documents.
The reasoning behind this comes down to how the CRA views the two types of financing. Leases (even Lease to Own agreements) are considered operating expenses, while bank loans are viewed as capital expenses. So, when you lease your equipment, you can deduct the total lease cost as an operating expense. Only the interest on a bank loan is viewed that way — not the portion of your payment that goes toward the principal.
A somewhat common exception occurs with passenger vehicles. Be aware that passenger vehicles are taxed differently than other businesses equipment. You can still deduct part of your lease payment, but the deductible depends on the percentage of business use versus personal use. For example, you have a truck with your business logo on the side, but it happens to be your personal evening & weekend vehicle as well. CRA will let you write off a portion of your payments, but not the whole, as it will be considered split usage and you can’t write off personal leases.
Don’t overlook the small stuff for tax savings. All leases for business equipment can potentially offer deductions. Leased computers, security cameras, printers, and even cell phones all qualify. As with passenger vehicles, only deduct the business use portion of the costs. For example, if you use your cell phone for business about 70% of the time and personal calls about 30% of the time, you can claim 70% of the lease cost on your business taxes. This can become a grey area for small business owners who work out of their homes. If you have a separate building for your business, CRA will assume all equipment in that space is used exclusively for business purposes. However, that same equipment used at home may be flagged if it is claimed as 100% a business expense. Talk to your accountant and work out together what percentage is reasonable to claim in your circumstances.
As with all financial matters, it’s important to talk to your accountant throughout the year. Planning and goal setting can go a long way toward good financial health for your business and a smaller bill at tax time.
Lease commitments: Deciding whether to lease or finance new equipment purchases should be done in cooperation with your banking institution. Depending on potential financing covenants (restrictions), the addition of lease obligations can have significant implications for any pre-existing financing requirements. While an operating lease will not show on your balance sheet as a liability, there is still a “commitment” to make payments over the lease term. This commitment to payments is an important factor to most lenders and should be discussed before making any decisions.
Interest rates: Interest rates are a function of risk assumed by the lender. The more security a lender takes reduces their risk and, as a result, should reduce the reward and interest rate charged. If less security is required, the risk to the lender increases and so too does the required return and interest rate charged.
Timing of acquisition: The purchase of a piece of equipment allows for the full amount of CCA to be deducted from taxable income in the year of purchase, regardless of the timing during the year. For operating and capital leases, only the lease payments paid during the year are deductible for tax purposes. This fact will impact the decision on whether the lease or purchase option provides the lowest overall cost. The example above assumes that the acquisition and leases were made at the start of the year.
Financing your equipment can have a significant impact on your bottom line. As with most tax issues, there are many variables and not all businesses are the same. Be sure to consult an expert accountant to find out how these benefits can be used in your business’s unique situation.
Find how leasing can help grow your business! Give us a call or fill out our form. Filing Taxes is an accounting firm operated by professional Accountants in Toronto & Mississauga who specialize in helping individuals and corporations reduce taxes and tax planning. Feel free to contact us through our website filingtaxes.ca or reach out at 416-479-8532. Schedule your tax preparation appointment with us and take the first step towards proper management of your finances. Our professional personal tax accountants will make sure to get you the maximum tax refund on your personal tax return.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.