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Fall 1999 

Introduction to Leasing
Buying vs Leasing
Taxable Benefits
Real Life Example
Common Lease Terms

Leasing vs Ownership of Business Assets

Is ownership of an asset favoured over leasing? This is a question that should be answered only when the economics of the decision can be separated from its income tax implications. The basic advantages of leasing are: (a) lower monthly payments compared to a bank. loan or lien note; (b) an additional source of financing when bank borrowing has reached maximum levels; (c) may insulate the lessee from equipment obsolescence when contracted for short periods of time; and (d) will not affect the liabilities side of company’s balance sheet and adversely impact company’s ability to arrange additional financing, if required.

Let us look at an example. Assume a company is considering the purchase or lease of a particular piece of equipment costing $50,000 today if it were to be bought outright. The asset is expected to have a resale value, in four years’ time, of $20,000 (residual value).

If the company does not have the funds available, it could choose to purchase this asset with a bank loan. The bank lends the funds to the company, who would then have to repay the loan at an interest rate that would be commensurate with their credit worthiness. Since the prime bank rate is somewhere between 7 and 8%, it would not be unreasonable to expect the company to borrow at a 10% rate of interest. This translates into blended (principal and interest) monthly payments of approximately $1,268.

However, if the company chose to lease the equipment, it would be considered as if the company had entered into a contract for its long-term rental. The lease payments would be determined by combining the asset’s reduction in value over the term of the lease (here, $50,000 minus $20,000), the interest rate that the leasing company must pay to finance their original purchase of the asset and any other charges, such as an administration fee and the desired profit margin, that the lessor is able to pass onto their clients.

To the extent that the required lease payments are less than $1,268 per month, then leasing, rather than purchasing the asset, appears to make sense.

One clause of the lease agreement covers what will happen to the assets when the lease is over. The lessee might be given an option to purchase the asset for the residual value that was established at the outset of the lease. A higher residual value typically requires the lessee to make lower lease payments, but it should not be set so unrealistically high that at the end of the contract, the lessee will be required to pay an amount that grossly over states the value of the asset at that time.

A second option is for the lessee to simply return the asset at the end of the lease, but then he will have to enter the entire process again if he wishes to continue having similar equipment to produce his product.

For income tax purposes, Revenue Canada may look beyond the terms of the lease contract and determine that the lease is a "financial lease" and little more than a "disguised purchase". This would be the case when the residual value is particularly low, say $1. They assume that the asset will hold its value beyond the term of the lease and that it is very likely that the lessee will exercise his option to purchase the asset at that time. Thus, the lessee would not be able to deduct the full amount of the monthly payments under the terms of the lease contract, but would have to "set up" the equipment as an asset of the company and take depreciation (capital cost allowance) at government prescribed rates. This may result in a lower write off of costs initially, although in the long run they will equal out and be the same.

Leases that do not attempt to cover the expected useful life of the asset and encourage the lessor to return the item at the end of the contract so that it may be re-marketed by the lessor are called "operating leases". Such leases allow the lessor to expense his monthly lease payments on a pay-as-you-go basis.

 

How to Save Money on Auto Insurance

In Canada, automobile insurance is legislated by the provinces and there are different schemes in different regions of the country. In British Columbia, Manitoba, Saskatchewan and Quebec the government has a monopoly on auto insurance, although some of these provinces allow for limited competition on optional coverage and vehicle damage. The other provinces have private auto insurance models. And statistics show that government insurers tend to offer lower premiums, especially Manitoba.

It is not just the auto insurance system that can affect the premium you’ll pay, but also the kind of car you drive. Our tastes in automobiles have changed over the years from two-cars and family sedans that were popular in the 1980’s to more sports-utility vehicles and passenger vans that we see on the road today. Our automotive transportation boasts the latest advances in technology making our vehicles both safer and more efficient. But because of their high price, more costly to insure.

Another element in the calculation of your annual automobile insurance premium is the kind of driving and driver that you are. Are you a prudent person who drives short distances to work or a rampant lane changer speeding from appointment to appointment, cell phone in one hand and business organizer and steering wheel in the other? Insurers monitor years of driving experience, average amount of driving distance per annum, traffic infractions and at-fault accidents very carefully and allocate premiums accordingly. Here are some tips to help you keep auto insurance premiums in line:

  1. Select a licensed insurance broker. He can be a good source of information and provide quotes from several different insurance companies. Ask family members or friends to recommend someone whom they find courteous and knowledgeable. Direct telephone insurers are employees of the company for which they work. They have particular rules to follow and if you fall outside of them, you will have no one to assist you in case of a problem later on;

  2. Wait for your current automobile insurance policy to expire before switching to a new insurer. Many companies penalize you for leaving them before the term of the current policy has run out;

  3. Find out your insurers policy on rate changes after an "at-fault" collision and/or comprehensive claim. Some companies will give existing clients a break, but others will not;

  4. If you have a teenager who will be driving in the near future, ask your insurer about their treatment of new drivers. Your child can qualify for a lower premium if he learns to drive at an approved ~ driving school. You may be in for an unpleasant surprise when your son is added as a secondary or occasional driver on your existing policy;

  5. Inquire whether you will be entitled to a special discount if you insure your car and home with the same insurer. Some companies give you a special rate if you combine the coverages, or if you insure more than one vehicle. In the event of an auto theft claim, personal belongings come under house insurance. If car and house insurance are with the same company, there will be only one deductible;

  6. Some cars and many sports-utility vehicles have poor claims or theft records that will result in higher premiums. Research the make and model of the car you are considering purchasing to see if these factors will cost you more over the term of its ownership;

  7. Approach your broker or insurance company representative for answers to questions or problems about your policy or claims. They will offer explanations in plain English. Beyond that, many insurance companies have an ombudsman in place to deal with consumer complaints or you can contact the Insurance Bureau of Canada or the Ontario Insurance Commission if you live in that province;

  8. Ask insurers about certain value-added programs that they might offer at no additional cost. These include 24-hour assistance and claims reporting lines as well as other support services that will come in helpful should an emergency come up;

  9. Find out from your broker or insurance company representative about the level of service they provide after a claim. Will they force you to patronize only certain auto repair shops, for example, and will they provide substitute vehicles following an accident;

  10. When you purchase a brand new vehicle, include coverage for "waiver of depreciation". For a small fee, the depreciation is cancelled in the event of a total loss within the first two years; and

  11. Don’t forget to buy loss of use coverage. This is especially important for people who need their automobile on a daily basis. For about $30 a year, a vehicle can be provided that would normally cost much more than that to rent for just one day.


Fall 1999 : Leasing vs Ownership of Business Assets | Introduction to Leasing | Buying vs Leasing | Taxable Benefits | Real Life Example  | Common Lease Terms


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