For years I have been trying to find a new owner for my small sailing boat. I had it financed with a loan supported by a secondary mortgage on my house. A month ago I sold it leaving a dent in my wallet. The transfer price was lower than the outstanding balance of the loan. I have torn my pants!
This reflects the risk of loss of value that the owner of an asset has if he/she purchased the asset or acquired it in a financial lease. A financial lease respects the desire of the lessee to ultimately obtain title to an asset. In other words,.. in a financial lease arrangement the risk of loss of value of the object is for account of the lessee. The lessor will expect continued payment of the lease amount, irrespective of the development of the value of the asset.
Very different from an operational lease, that is comparable to rent. You rent a nice little sailing boat in Greece or Croatia and at the end of your well-deserved holiday you return it to the lessor. Apart from the rental fee, that will certainly be much higher than what the Mediterranean lessor paid himself for the financial lease on the same yacht, no headache. An operational lease is similar, at the end of the leasing period you can return the asset to the lessor. Often the lessee (= the customer leasing or renting the asset) can purchase the object from the lessor. However, there is no obligation to do so.
WHAT DOES THIS MEAN FOR YOU AS A LESSEE?
A) Financial lease:
In case of a financial lease you immediately become the economic owner of the object. The investment is capitalised on your balance sheet. Possibly you qualify for capital allowances or other fiscal facilities. In your lease proposal we have already included a calculation of the kleinschaligheids-investerings aftrekregeling (KIA) for this investment. This calculation is uncommitted as the tax authorities make the ultimate decision on this.
B) Operational lease:
An operational lease resembles a rental. The machine is wholly owned by the lessor. It is capitalised in his balance sheet. Therefore you do not qualify for the Kleinschaligheids investeringsaftrekregeling (KIA). Usually the monthly rentals are lower because of the computed residual value at the end of the agreed term of the lease.
At the end of the agreed term of the operational lease you have the following options:
- You return the object to the lessor; or
- You purchase the object for a price agreed or to be agreed (purchase option); or
- You extend the lease agreement for conditions to be negotiated.
The lessor will not fully amortise the machine over the term of the lease. The lessor will often require a residual guarantee from your supplier.
The price that you can purchase the machine for at the end of the lease term may be agreed up front. However the price may also be agreed with the lessor at the end of the leasing period.
If at the end of the lease you decide to buy the machine the original supplier will sometimes be involved in this transaction. This is usually the case if the supplier provided a residual value guarantee to the lessor.
Maintenance
Because of the residual value exposure the proposal for an operational lease will require a maintenance contract with your supplier.
NOTE
Many companies will have a preference for a financial lease because of the investment allowances. On the other hand many leasing companies will prefer an operational lease because their title to the equipment will be better protected against seizure by the tax authorities in case a lessee goes bankrupt. To set your expectations right you should realise that an operational lease may sometimes be a condition for a credit approval. Sometimes credit approval depends on this.
On the other hand a downpayment may improve the chances of a credit approval for a financial lease.
