Investing in Equipment: Lease or Buy?
By Bo Mocherniak
At some point as you grow your business and invest in new construction equipment, you’ll no doubt ask yourself: Should I lease or should I buy?
There’s no clear-cut answer—lease or purchase decisions depend on many factors, including your current cash flow situation, the length of time the equipment is needed, and other business and tax considerations. Leasing might be the best option for those who simply don’t have the cash on hand since many leases require little or no down payment. Likewise, leasing may be the preferred option if the equipment is only needed for a short time, such as a specific project, or if the equipment could become obsolete relatively quickly. If you are considering leasing, talk to your banker and accountant about whether or not the lease obligations could adversely impact any pre-existing financial covenants or restrictions you may have.
Purchasing equipment may be preferred if you have the cash to pay in full—especially since the lease costs are higher because you’re also paying interest. There are also some tax considerations to take into account.
While an equipment purchase itself isn’t a deductible expense for tax purposes, you can deduct depreciation on the equipment for each year that it is available for use in the business. It is worth familiarizing yourself with the basics of how depreciation works.
Understanding Capital Cost Allowance
Depreciation for tax purposes is called a “capital cost allowance” (CCA). Under Canada’s Income Tax Act, depreciable assets are grouped into more than 50 classes according to their type and use, each with its own rate of depreciation. Most classes of assets are depreciated on what’s called a “declining-balance” basis, which means the rate is applied to the depreciated value (not the price you paid when you first bought it) each year. Also, for most classes, the maximum amount of CCA that can be claimed in the year the asset is acquired is half of the normal CCA rate—this is known
as “half-year” rule.
Construction equipment that can be moved from place to place (including portable camp buildings used at construction sites) generally falls under Class 10, for which CCA can be claimed at a maximum rate of 30 per cent each tax year on a declining-balance basis. Power-operated movable equipment (designed to be used for excavating, moving, placing or compacting earth, rock, concrete or asphalt) is generally included in Class 38, which has the same maximum CCA rate and depreciation method.
Equipment and machinery used in the manufacturing or processing of goods for sale falls under Class 29, which is eligible for an accelerated CCA rate. If the equipment was acquired on or after March 19, 2007 and is primarily for use in Canada, it qualifies for a maximum 50 per cent accelerated CCA rate claimed on a “straight-line” basis, which means the rate is applicable to the purchase price each year, rather than the depreciated value. This accelerated rate only applies for eligible purchases made up to the end of 2015, so you may want to consider making eligible purchases before the accelerated rate ends to take maximum advantage of the tax savings. Eligible manufacturing or processing equipment acquired after 2015 will go into Class 43, for which CCA can be claimed at a maximum rate of 30 per cent each tax year on a declining-balance basis.
If you borrow money to finance the purchase of equipment, you can generally deduct the related interest expenses. Make sure that the terms of the loan are eligible for interest deduction. This will almost certainly be the case if you approach your bank, but if you borrow from friends or family, get your lawyer to draw up a legal agreement that meets the criteria for interest deductibility.
If you decide to lease equipment instead of buying it, be aware that the tax treatment depends on whether the lease is treated as an operating lease, or a financing lease or sale for tax purposes (also called a capital lease). Under an operating lease, payments (both principal and interest components) are fully deductible just as you would deduct rental expenses, but you cannot claim any CCA deductions. In a financing lease (in which the legal agreement is structured as a sale for tax purposes), you can capitalize the asset and claim CCA just as you would with an outright purchase.
As you can see, there’s no one-size-fits-all solution, so professional advice is strongly recommended before you make a final decision to lease or buy.
With over 30 years experience with audit, acquisitions, divestitures and valuations, Bo Mocherniak, CA, CBV, provides services to both public and private companies in Canada and the United States. Bo is National Sector Leader for the Real Estate and Construction Group of Grant Thornton Canada, a member of the Grant Thornton International Real Estate Sector Group and past Chair of Grant Thornton LLP. He can be reached at email@example.com.