The assets may be financed by way of an instalment sale, operating lease (rental) or finance lease. However in making this decision, the income tax, Value Added Tax (VAT) and accounting implications of each agreement should be taken into account.
An instalment sale means that an asset is acquired by paying instalments over an agreed period. The title of the asset passes automatically, once the full amount has been paid.
A finance lease provides the use of an asset for an agreed period, during which rental is paid. At the end of the term of the finance lease, the asset can be returned, ownership may be acquired or the lease term may be extended.
An operating lease works similarly to a house rental, where the lessee does not take on the owner’s responsibilities with respect to the asset. The lessee has the use of the asset for a fixed period.
From an income tax perspective, the lessee subject to a finance lease and operating lease, does not acquire ownership of the asset and therefore cannot claim capital allowances in respect of the asset. The lessee can claim a deduction of the lease rentals paid.
In the case of an instalment sale agreement, the acquirer will be regarded as the owner of the asset. The acquirer can claim capital allowances in respect of the asset and finance costs related to the asset, as a deduction in terms of the agreement.
An instalment credit agreement is specifically defined in the VAT Act and for VAT purposes. A finance lease is treated in the same manner as an instalment credit agreement.
From a VAT perspective, finance leases and instalment credit agreements are treated in the same manner. The purchaser/lessee may claim an input tax deduction of the full amount of VAT included in the purchase price of the asset at the commencement of the finance lease or instalment sale agreement.
Where the asset is subject to an operating lease, the lessee will only be permitted an input tax deduction when monthly rentals are paid.
From an accounting perspective, a finance lease is a lease that transfers substantially all the risks and rewards incidental to the ownership of an asset, but title may or may not eventually be transferred. Where the relevant criteria are met, for accounting purposes finance leases may be capitalised. Instalment sale agreements are capitalised for accounting purposes and operating leases are treated as rental payments.
It is therefore essential when dealing with leases and instalment credit agreements in financial statements and tax returns, that the income tax consequences as well as the VAT consequences are not overlooked.