—Sponsored article by Blue Chip Leasing
We’re already close to the end of January and having spent almost two decades in the machinery industry, I can tell you the calendar year generally starts off slowly, and is quiet in terms of purchasing financing.
Why? As a general rule, most companies tend to put off equipment purchases until the fall; usually because they want to see how the year goes before making a big commitment, or they’ve been too busy all year to spend the time necessary to research and source the right piece of equipment.
By the end of the year though, they’re under pressure to get it done because budgeted money needs to be spent or it will be lost going forward, or there are financial reasons to get a purchase “on the books” before the year end.
Whether you invest early in the year or later, the timing of your equipment purchase or lease depends on a few tax and accounting considerations.
The balance sheet
When a piece of equipment is bought outright, you take on ownership, meaning the equipment becomes an asset on your balance sheet. Standard company balance sheets have three parts: assets, liabilities and ownership equity.
The difference between the assets and the liabilities is known as equity, or the net worth of the company. From a taxation perspective, the benefits of ownership allow the company to depreciate the asset, which is a fancy way of saying they’re reducing earnings and in turn, paying less tax.
But if the purchase happens near the end of the financial year, the tax savings become minimized because the full year’s depreciation can’t be taken. In this case, a preferred method of handling the transaction is an operating lease.
Accountants classify equipment leases into two main categories: capital leases and operating leases. Capital leases are treated in a fashion similar to the outright purchase of the equipment (or bank loan).
An operating lease is a contract that allows for the use of an asset but doesn’t convey rights of ownership. In fact, the leasor maintains ownership. The equipment isn’t put on the books as an asset but instead, accounted for as a rental expense in what is known as “off balance sheet financing.”
Operating leases have tax incentives as well, but don’t result in assets or liabilities recorded on the balance sheet. From a financial perspective, and due to the nature of the asset, the company’s efficiency will improve dramatically since new income-generating equipment has been installed, allowing the company to return more sales and boost profits.
Another ancillary benefit of the lease—capital or operating—is how GST or HST are handled. Even though most businesses get all GST or HST they’ve paid back at some point, when equipment is purchased—or if the funds are borrowed from a bank—the federal and provincial taxes are either paid in cash or must be borrowed as well (and the interest paid).
When the equipment is leased, the leasing company pays the taxes in full up front because it’s the entity taking ownership. The lessee pays tax on each payment, so there’s a positive impact on a company’s cash flow.
The most important takeaway is to look beyond the dollars and cents of an equipment purchase and ensure you talk to your accountant or auditor before finalizing. This will allow you to strategize how best to handle it from a financial perspective.
Ken Hurwitz is senior account manager with Blue Chip Leasing Corporation, an equipment finance company in Toronto. Ken has years of experience in the machine tool industry and now works to help all types of manufacturers either source or tap into their own capital to optimize their operations. Contact Ken at (416) 614-5878 or at via email. Learn more at www.bluechipleasing.com
View more of Ken’s articles in the Financial Management Success Centre