Written by When it comes to locking in the right deal for the commercial asset you want to finance, it’s important to know what your options are. For leases, there are two main options you might’ve heard of: finance and operating leases. But how exactly do they work and when might they suit your business? Take a deep dive into your leasing options with Savvy to help you work out which is best for you!
What is a finance lease?
A finance lease is a finance arrangement where you rent your asset for a set period before buying or selling it (more on that in a bit). Essentially, how this works is that, once you decide on what you want to lease, your lease provider purchases the asset and gives you access to it for a set term.
Terms can range from one to five years in length, while the cost of your payments will vary depending on how long you’re leasing your asset, the value of the asset and your leasing company’s other charges, such as interest and fees.
You can choose whether to include on-road costs in your payments (which is known as a fully-maintained lease) or keep them separate and organise them yourself (known as non-maintained leasing).
As a business expense, you can claim up to 100% of your lease payments as a tax deduction, though this will ultimately depend on how you use your asset. For example, using your business car for private purposes 20% of the time means you’ll only be able to claim 80% of your lease payments. Speak with your accountant if you want to know more about your specific situation.
What is an operating lease?
The other main leasing option you’ll come across is an operating lease. Although similar to finance leases in many ways, there are several key differences between the two that are important to know.
The biggest change you’ll notice from a finance lease is that operating leases don’t have a residual payment at all. Under one of these agreements, there’s no requirement for your business to buy the asset; instead, your leasing company carries the risks of ownership and obsolescence. You’ll simply hand it back at the end of the term.
That makes these leases more suited to businesses who only need to use them for a short period or like to refresh their vehicles or equipment regularly. However, it’s worth noting that the selection of assets you can lease is generally limited to road vehicles like cars, buses and trucks.
The tax benefits of this type of lease are the same as they are with finance leases, while you’ll also be able to opt for either fully-maintained or non-maintained.
Finance leases vs operating leases: explained
| Finance lease | Operating lease | |
|---|---|---|
| Ownership lies with: | Lessor, until being transferred to lessee after residual is paid | Lessor at all times |
| Usage requirements are: | At least 51% commercial | At least 51% commercial |
| Residual is: | Included | Not included |
| At the end of the lease, you can: | Buy the asset Sell/trade in the asset Refinance the residual and extend the lease | Return the asset to the lessor |
| Lease terms range from: | One to five years | One to five years |
| Assets you can lease include: | Commercial and non-commercial vehicles and equipment | Road vehicles |
| On-road costs: | Can be included (fully-maintained) or excluded (non-maintained) | Can be included (fully-maintained) or excluded (non-maintained) |
| Tax deductions include: | Lease payment, GST on the asset purchase and other on-road costs (subject to your business usage) | Lease payment, GST on the asset purchase and other on-road costs (subject to your business usage) |
What is a finance lease residual and how does it work?
At the end of the lease, ownership (and responsibility for running or getting rid of the asset) is transferred to you once you pay the residual. This is a value attached to the end of your agreement that you’ll have to pay as a lump sum. As mentioned above, there are several ways to go about dealing with it, including:
- Paying the residual out of pocket and purchasing the asset
- Selling or trading in the asset, using the money to pay the residual, and ending the lease
- Selling or trading in the asset, using the money to pay the residual, and starting a new lease
- Refinancing the residual and extending your lease by up to two years
Leasing companies set their residuals based on the mandatory minimum for each lease term required by the ATO. The following percentages represent the minimum you’ll be required to pay at the end of your lease term:
- 12 months: 65.63% of purchase price
- 24 months: 56.25%
- 36 months: 46.88%
- 48 months: 37.50%
- 60 months: 28.13%
These are only the minimums required by law. Your leasing company may offer (or require you to pay) a higher residual than the minimum.
So, what costs are included in a fully-maintained lease?
Although each provider will have its own lease product and inclusions, the following are some of the most common costs included:
- Comprehensive insurance
- Fuel
- Roadside assistance
- Servicing and maintenance
- Tyre replacement
- Vehicle registration
The big benefit of this is that it saves on time and energy otherwise spent doing admin and organising each of the above. However, by leaving these to your leasing company, you may not get as good a deal as you would by comparing and organising them yourself. For instance, some companies may only partner with one or two insurers, while you might prefer to survey the market.
What’s the difference between finance or operating leases and novated leases?
A novated lease is another type of product entirely. While finance and operating leases are for businesses using vehicles and equipment for commercial purposes, novated leasing is designed for employees and can be used however you like.
Compared to the other leases we’ve spoken about, they work very differently in terms of how they’re paid. They’re what’s known as a salary sacrifice agreement; essentially, your employer leases the car on your behalf and gives it to you to drive, deducting the lease payments from your pre-tax salary.
This presents some attractive tax benefits for employees. Perhaps the biggest is the reduction in income tax, as their taxable income will be lowered thanks to the pre-tax deductions. GST is also claimable on the purchase by the leasing company, which can be passed onto the employee as savings.
As we spoke about before, though, this isn’t an alternative to the other leases: it’s its own product entirely. Business owners who pay themselves a salary and want a car for private use may be able to take out a novated lease, but you otherwise won’t be able to.
Which leasing option is best for me?
Whether one option is better for you than another will ultimately come down to your business and what you’re looking to get out of it. While we obviously don’t know your specific circumstances, here are some factors to keep in mind:
- Operating leases generally aren’t available for equipment
- If you’re looking for short-term leasing with regular updates to your assets, operating leases allow you to do this more easily
- If you want to keep the option of buying your vehicle or equipment open but don’t want to fork out straight away, finance leases enable you to do that
You can speak with one of our friendly consultants to find out more about the options available to you as a business owner by applying with us today. Simply fill out our no-obligation quote form and we’ll be in touch to walk you through the options on offer!
