Types of Car and Equipment Loans

Finance Lease: Ownership of the equipment is with the Lessee (the Business). It is an on-balance sheet. The full payments to the lessee are tax deductible. At the end of the lease, the equipment is returned to the Lessee or purchased by the business for an agreed price.

Operating Lease (Rental): Ownership of the equipment remains with the Lessor. It is an off-balance sheet. The full payments on the financing are tax deductible. At the end of lease, the lessee returns the equipment to the lessor or purchased by the business for an agreed price.

Commercial Hire Purchase: Equipment is owned by the borrower (business). It is treated as an on-balance sheet finance. Only the interest portion of the payments is tax deductible. The business can claim depreciation deductions on the equipment. At the end of the term, the equipment remains with the company. There may be a residual value payment required at the end of the loan term.

Chattel Mortgage: Equipment is owned by the borrower (business). The interest component of payment is tax deductible. The business can claim depreciation deductions on the equipment. This is a traditional secured loan where the equipment acts as security for the Lender. At the end of the finance term, the borrower remains as the owner of the equipment.

Consider the following before applying for a Car or Equipment Loan:

1. Tax: Operating and Finance Lease payments are fully tax deductible (vs Chattel Mortgage and Commercial Hire Purchase, where only the interest component of the payment is tax deductible). This needs to be weighed against the fact that under a Chattel Mortgage and Commercial Hire Purchase the business can claim depreciation on the equipment (this is not the case under Operating Lease and Finance Lease structures as the equipment in these cases is owned by the Lessor and not the business). Some financial modelling is required in order to determine which product is the most tax efficient.

2. On Balance Sheet vs. Off Balance Sheet: Business owners may have a preference as to whether they have legal ownership over the equipment and carry it on its balance sheet or whether the equipment is held on someone else’s balance sheet.

3. End of Term Risk: With Chattel Mortgage and Commercial Hire Purchase, the equipment is owned by the business and there is no end of term risk. For operating and finance lease, there is end of term risk for the business (i.e. may not be able to purchase equipment from Lessor or Lessor may require a higher than market payment for ownership transfer).

4. Flexibility: Operating leases in particular can be structured to give the renter a high degree of flexibility. This may include the ability to return the equipment before the end of the lease. It may also include an option to purchase the equipment outright during the lease term or to upgrade equipment.