When it comes to getting a car, the decision of whether to lease or finance can be a daunting one. As a business owner, the decision to buy or lease a vehicle under a corporation in Canada can be complicated and requires careful consideration. Both options come with a different set of advantages and disadvantages, and making the right decision is entirely based on your personal needs and situation.
The good news is that you can deduct the business percentage of your gas, oil, insurance, parking fees, registration fees, lease, repairs, tires, loan interest, etc. for both leased and purchased vehicles.
Understanding the Difference Between a Lease and Finance Agreement?
Ownership is the main difference between lease and finance agreements. With lease agreements, you return the car to the dealer at the end of the contract, and your payments cover the depreciation of the car’s value. Leasing is the same as renting. You don’t own the car, but you usually have the option to buy it at the end of the term.
With finance agreements, every payment you make goes toward owning the car, and when the loan is paid off, you have 100% equity. Loan payments are usually higher than leasing since you're covering the entire value of the car.
When you finance a vehicle, you’re entering into a contract with a lender where you agree to make payments over a set period. Dealerships have relationships with a ton of lenders who can work with individuals facing a wide variety of financial situations. Once you’re approved for auto financing, it’s your responsibility to make all monthly payments on time and in full.
Although monthly payments on a lease are generally cheaper than financing, lease agreements come with annual kilometer restrictions, early termination stipulations, and accumulative wear & tear charges that should be taken into consideration if you're trying to decide what type of finance is right for you.
Should you buy or lease? What are the tax deductions for cars? These are some of the most common questions accountants get from small business owners, and the answer is that it depends.
Tax implications of Leasing a Vehicle in Canada
A lease works like a rental where you make regular payments, but don’t own the asset at the end of the lease term. An advantage of choosing the leasing method is that you generally aren’t on the hook for major repairs since the dealership still owns the car. You can deduct 100% of your lease payments if you use your car solely for business.
When leasing a vehicle, the limit on deductible lease cost is $800 per month, before HST. This means that if your lease cost is $900 per month, before HST, you’re restricted to claiming only $800 each month. However, the amount you can deduct for tax purposes is restricted further.
In the same example as above, if you use the vehicle 80% for business purposes during the year, and 20% for personal use, then the amount you can deduct is now just $640 per month, before HST – the rest of the cost is considered personal use and is not deductible for tax purposes. This limit is further ground down by a formula based on the list price of the vehicle. This formula is designed to prevent people from purchasing expensive luxury vehicles and deducting the full amount of the lease payments.
One of the top disadvantages of leasing is the depreciation deduction. You aren’t able to take any depreciation on the vehicle since you don’t own it. This can be a major tax disadvantage depending on the vehicle’s purchase price.
Tax Implications of Financing (Buying) a Vehicle in Canada
Buying a business vehicle does come with its share of advantages. First, you are able to make payments toward owning the asset if you don’t have the capital to buy the vehicle outright. Additionally, interest expense is a qualifying business deduction when you purchase a vehicle.
Financing a vehicle implies that you’ve taken out a loan to purchase the vehicle. You still have monthly payments, but you’re considered to own the vehicle. You’re eligible to deduct the interest on a financing loan, up to a maximum of $300, per month.
Again, like in our leasing cost example, this is further restricted based on your business use percentage of the vehicle each year. To calculate your business use of your vehicle, divide the number of kilometers driven for business purposes during the year by the total number of kilometers you drove in the year.
The CRA allows you to take a percentage deduction throughout the vehicle’s useful life in depreciation. This can significantly reduce your tax burden. Since you own the vehicle, you’re also permitted to deduct Capital Cost Allowance (CCA). The Capital Cost Allowance is based on the vehicle’s purchase price, class, and business use. The rate of this deduction is 15% of the total purchase price in the year of the vehicle acquisition and at a 30% declining balance rate each year thereafter. The amount of CCA that can be deducted is further restricted based on your business use percentage of the vehicle each year.
Another important consideration is that the total purchase price in the CCA calculation is often restricted on passenger vehicles to just $30,000, before HST. This means that if a passenger vehicle was financed for $45,000, before HST, you could only claim the CCA deduction on the first $30,000 of the vehicle purchase price, assuming you’re registered for HST. If you are not registered for HST then the HST can be claimed as part of the purchase price. The Canada Revenue Agency views passenger vehicles in excess of $30,000 to be luxury vehicles and therefore restricts the deduction for tax purposes.
There are disadvantages to consider as well. First, you are liable for all repairs and maintenance since you own the vehicle. Luckily, these expenses do qualify as a business deduction. Moreover, when you dispose of the vehicle, you may be required to pay capital gains tax and recognize depreciation recapture rules.
Considering Other Factors: Leasing Vs Buying
While the tax implications are important, there are other factors to consider when deciding whether to finance or lease a car. Let’s take a look at some of the pros and cons of each option:
Financing(Buying) a Car
- Pros:
- Ownership: You will own the car.
- No mileage restrictions: You can drive as many miles as you like.
- Ability to customize: You can customize the vehicle to your liking.
- Lower insurance cost: Insurance costs are generally lower for owned vehicles.
- Cons:
- Higher monthly payments: Financing a car often requires higher monthly payments compared to leasing.
- Higher maintenance cost: As the owner, you are responsible for maintenance and repairs.
- Depreciation risk: The value of the car may decrease over time, potentially impacting its resale value.
- Possible negative equity: If the value of the car drops significantly, you may owe more than it is worth.
Leasing a Car
- Pros:
- Lower monthly payments: Lease payments are generally lower than financing payments.
- Less maintenance cost: Leased cars are typically under warranty, reducing maintenance expenses.
- More flexibility: You can change cars more frequently, usually every few years.
- No hassle of selling: At the end of the lease, you simply return the car without worrying about selling or trading it in.
- Cons:
- No ownership: You do not own the car and must return it at the end of the lease term.
- Mileage restrictions: Most leases come with mileage limits, and exceeding them can result in additional fees.
- Fees for wear and tear: If the leased car shows excessive wear and tear, you may be responsible for additional charges.
- Higher insurance cost: Insurance premiums are often higher for leased vehicles.
Get Professional Help in Choosing the Right One
Choosing the right method takes into consideration different factors. First, analyze the purchase price versus the lease price. Buying an expensive vehicle will come with greater interest and loan costs while leasing might be more cost-effective for your business.
Also, consider how long you plan on keeping the vehicle. If you only plan on having the vehicle for a couple of years, leasing might make more sense to avoid capital gains taxes. The mileage you drive each year will also help you make your decision.
You want to be sure you are making the decision that positively impacts your taxable income. To work through your situation with an expert, reach out to the team at Filing Taxes. We can put together a cost breakdown related to your specific situation to help you make the most informed decision. Reach out today for more information.
If you have any questions or need further clarification on the topic, please feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step toward proper management of your finances.
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.