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When money is tight, leasing makes sense

10th April 1982, Page 22
10th April 1982
Page 22
Page 23
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Page 22, 10th April 1982 — When money is tight, leasing makes sense
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Which of the following most accurately describes the problem?

Leasing is a very flexible form of finance. David Wilcox has been investigating how you can bend it to your advantage

THE OLD ADAGE "Possession is nine tenths of the law" does not always ring quite so true these days. That Eric Bilgepump's name appears on the side of a lorry does not necessarily mean that Eric Bilgepump owns it.

This is a reflection of the many ways in which an operator can acquire his vehicles. Apart from the most straightforward method, outright purchase, there is rental, hire purchase, leasing and contract hire. Each has its pros and cons but undoubtedly the most complex — and so most frequently misunderstood — is leasing.

In some quarters leasing is still regarded as a less-thanproper way of financing the purchase of new capital equipment such as a commercial vehicle. Some people who do lease equipment like to keep the fact to themselves.

The more enlightened operator does not place so much emphasis on who actually owns the vehicle; he knows that it is the vehicle's use and not its ownership that generates profits.

"A contract by which one party (the lessor), usually in consideration of rent, conveys land or tenement to another (the lessee) for a specified time." That is the dictionary definition of a lease. Leasing is by no means a new development; expensive equipment for the coal and railway industries was leased in the nineteenth century.

But the real growth in equipment and plant leasing took place during the post-war period in the United States and in Britain in the late 1950s.

The amount of plant and equipment leased in the UK has grown steadily since then, and included in this has been the leasing of commercial vehicles.

Why should an operator choose to lease his vehicle or even an entire fleet? Is it because he has something to hide? Maybe he just can't afford to buy it. Perhaps he has studied the ins and outs of vehicle acquisition and methods of finance and decided that leasing makes sense. Despite "expensive money", are you foolish to buy a vehicle outright in these inflationary times?

The most commonly cited reason for any type of deferred payment system (HP, leasing or contract hire) is that it avoids the need to lay out the large sum of money purchase the vehicle outright. rou have not got the money in first place then you won't ve much choice, but even if u can afford the purchase ice a deferred payment rthod frees money that would lerwise be tied up in the hide.

(ou can therefore use this :ra money that is now availle to invest in something else it will generate more money. rhis principle is sound proled you do actually use the 3ilable money profitably.

t must generate money to off: the "middle-man's" finance 3rges in the leasing/HP/conct hire deal.

rhe other major advantage of ferred payment systems is it inflation effectively reduces r cost of the repayments w remain constant in money ms but decrease in real terms. rhese two benefits apply to all pes of deferred payment stems. To sort out the finer ferences between HP and ming, one has to delve a little eper and venture into the )rld of taxation.

rhat dictionary definition of ming contains the clue to the major difference between HP and leasing. With HP, the operator becomes the legal owner of the lorry when he has paid the final HP instalment to the finance company.

But under a leasing deal, by definition, the operator (the lessee) never acquires ownership of the vehicle, which always remains with the finance company (the lessor).

The lease period for commercial vehicles normally varies between three and five years, with vans at the shorter end of the timescale and the more expensive tractive units usually financed over five years. During this time the finance company expects to recover the cost of the vehicle, the cost of extending the lease revenue over the lease period and, of course, to make a profit.

Lease repayments (called rental) are normally payable monthly, quarterly, half yearly or yearly. One of the advantages of leasing is that the initial deposit that is usually demanded with HP (20-25 per cent) is not needed; one rental payment in advance should be sufficient in a lease deal.

Although an operator buying a lorry on HP does not become the legal owner until the final instalment is paid, for tax purposes he is treated as the owner from the outset. Therefore, the oper ator can immediately subtract 100 per cent of the lorry's purchase price from his earnings before tax, thus reducing his taxable earnings as soon as he gets the use of the vehicle. It is this that is termed "100 per cent tax allowance in the first year" by the finance people.

Conversely, in the case of a lorry that is leased, because the finance company is always regarded as the owner, it is the finance company not the operator that claims the 100 per cent tax allowance in the first year.

So what does this mean to the operator? After claiming the tax allowance in the first year with a lease deal, the finance company passes on some of this tax benefit in the form of lower rental payments for the operator.

In addition to this, the lease rental payments are treated as a trading expense and the operator can deduct these from his earnings, once again reducing his tax bill. If the vehicle is being bought on HP, because the operator's tax allowance is made in the first year it is only the finance (interest) charge element of each repayment that can be claimed against taxable income. The vehicle's normal depreciation also qualifies for tax relief in an HP deal.

So, as far as tax is concerned, an HP deal offers savings in the first year of the deal whereas leasing spreads the tax benefits across the length of the lease period say, five years.

Although the tax advantages occur earlier with an HP deal, the necessity to put down an initial deposit can detract from HP. As mentioned earlier, in days of high or increasing inflation, any deferred payment system with a fixed repayment is more attractive as time goes on and the real value of the repayment decreases. Since leasing deals tend to be over longer periods than HP, this seems to favour leasing.

Of course, the finance company will take account of inflation when fixing the rental, but this has to be based on guesswork. So if inflation increases beyond what the finance company expect, the lessee will benefit; if inflation is lower than anticipated the finance company benefits.

To set against this element of risk the operator can budget more easily by leasing his vehicle. Instead of allowing for peaking expenditure when he needs a new vehicle and taking into account depreciation, leasing means the operator has a regular, fixed rental to pay instead.

"Off balance-sheet accounting" used to be given as a good reason for choosing leasing. In other words, the liability of paying the rental on the vehicle is omitted from the operator's balance sheet, therefore making the gearing (liabilities: assets ratio) look better than it actually is. In recent years the accountancy profession has pressed for leased equipment to appear on the balance sheet, so this point might soon be invalid.

It's difficult to 'be categorical about leasing; the very nature of leasing is that it is a flexible form of finance and various packages can be put together. The most comprehensive is contract hire which can be regarded as a form of leasing that goes beyond pure financial measures and starts to incorporate operational factors.

Contract hire seems to be quickly gaining in popularity at the moment and future pros pects are bright. It offers similar benefits to leasing — freeing of capital, tax advantages and easier budget planning — but by providing vehicles and maybe drivers and maintenance as well, contract hire promises to take all or part of the operational burden off the lessee's shoulders. This would obviously appeal to the man who is not a haulier by profession, but is merely using the lorry to carry out his real business.

For a small business such as an owner/driver, HP is the most obvious choice for finance when buying a tractive unit for around £25,000. But, in fact, it is possible that he may not be able to take full advantage of the 100 per cent tax allowance in the first year with HP — his profit in that year might not be sufficient to utilise fully the tax allowance accruing from the vehicle's purchase. In this instance, the longer term tax benefits of leasing would appeal.

Unfortunately, it is the smaller operator who is least likely to get a leasing deal on a new lorry. Firstly, he might not be aware of the pros and cons of leasing (and it is sometimes difficult to get leasing explained in plain English).

But, more significantly, finance companies are often reluctant to arrange a leasing deal with a small, new business or one without a good track record.

Part of the explanation for this is that as a lessor the finance company is classified as an unsecured creditor. Should an operator go into liquidation, the finance company is well down on the list of creditors.

According to the finance companies, they will be more likely to provide a lease deal if they believe that the operator wants to lease his new vehicle for the right reasons, ie tax advantages, freeing of capital, easier budgeting, and so on. But if the finance company suspects the real reason is that the operator can't get an HP deposit together, for instance, then a lease deal is not likely to be offered.

Even if the operator does appear to be a good risk and has a sound business he might still find it hard to get lease finance. This is nothing to do with the operator. It stems from the fact that the majority of finance companies are offshoots of banks and the other financial institutions. The finance company is often used as an instrument to manipulate the bank's own tax position and so the amount of lease finance it offers may be restricted. It all depends on the individual bank's position at the time.

The moral of this is to shop around when it comes to looking for a lease deal. If the vehicle is being bought from a truck distributor then it is likely that your application for a leasing arangernent will be passed on to a particular finance company that has an arrangement with the distributor or vehicle manufacturer. This is not necessarily the best leasing deal available, but the chances of getting leasing finance are probably greater.

"Lease with option to purchase" is a term that is fairly common in commercial vehicle finance but is rather misleading. Despite its name, it is not a. form of leasing in the strictest sense; if the operator is able to buy the vehicle, it cannot be a lease deal.

With a lease with option to purchase arrangement, at the end of the lease period the operator pays a nominal sum (£1) and acquires ownership of the lorry. It is therefore a hybrid type of finance, half leasing and half HP. No initial deposit is necessary, unlike HP, but for taxation purposes it is treated

like HP and the operator claim the 100 per cent tax allo, ance in the first year.

As the accompanying grap show, the leasing of commerc vehicles was down last ye after steady growth in ti preceding years. This was harc surprising and reflected ti overall slump in commerc vehicle sales.

During 1981, commerci vehicles worth £225m we leased from the members of tl Equipment Leasing Associatio This body represents 58 leadii finance companies and so should give a fairly accurate pi ture of the industry as a whole. so, leased vehicles represe about 15 per cent of the ne commercial vehicles registen last year.

Despite this drop in last year figures, the finance companii can reasonably expect the di mand for commercial vehic leasing to pick up during 198 Many operators have put off r placing vehicles for the la couple of years and they mu be planning to buy some ne vehicles soon, especially if tt economy is on the road to reco, ery.

In these circumstances ft need for vehicles could b strong but the money will still I tight and so leasing could be a attractive proposition.


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