Leasing: vital for many businesses

The concept originates from the United States.

For many businesses, leasing is an interesting alternative to traditional loans. It is a good way for businesses to finance acquisitions without having to draw on their own equity.

Leasing as a product originates from the United States and represents the granting of a special type of transfer of right to use an asset. This alternative investment was introduced from the US by business pioneers in the 1970s. Today, it is hard to imagine everyday business life without leasing; it has become an indispensable pillar of corporate financing. Leasing accounts for over half of all investments. In a civil law sense, it is a non-standard rental agreement. This type of financing option involves the procurement and financing of the asset by the lessor, who then transfers it to the lessee for use against payment of an agreed fee.

There are essentially three different types of lease agreements: financial, operational and real estate.

Three types of lease

There are essentially three different types of lease agreements: financial, operational and real estate.

A financial lease is a contract for an asset intended for business use, in which an irrevocable lease term is stipulated. At the end of the contract period, the entire acquisition price of the asset, including additional costs and financing costs, is repaid in principle. With a leased asset (a “movable asset”), the asset can be a vehicle (car, commercial vehicle, trailer, bus, etc.), and also includes industrial equipment, construction machinery and equipment for offices and shops. Medical equipment, office technology and IT equipment can also be covered by a financial lease.

An operational lease includes various services that go beyond the lease of an asset. When buying a car this might include insurance and maintenance of the vehicle over the duration of the lease. Generally, this type of contract does not include a purchase option at the end of the contract period.

Real estate leasing refers to buildings. As this lease type is not eligible for tax relief, it is relatively uncommon in Luxembourg.

A popular financing option

Financial leasing – accessible to all kinds of businesses from self-employed professionals to retailers and large corporations – is very popular and allows businesses to optimise their investments.

While differences exist between individual financial institutions, there are certain principles in common in terms of how finance leasing works in Luxembourg.

In principle, the lessee selects their preferred equipment and supplier.

In principle, the lessee selects their preferred equipment and supplier. The leasing company then acquires the necessary equipment, of which it remains the owner. It leases it to the customer by transferring the right to use it for a certain period of time against a lease rate. The lease rate is payable monthly, quarterly, semi-annually or annually.

At the end of the contract, the three options available to the lessee are to buy the equipment at the originally agreed residual value, extend the lease, or return the equipment and potentially enter into a contract for new equipment.

Tax benefits

Without doubt, the main benefits involve fully financing the price of the asset (including the pre-financing VAT) by the leasing company payment of a pre-determined lease rate for the entire duration of the asset’s use. Some leasing companies also offer non-linear lease rates. This way, companies can increase their liquidity whilst benefiting from an alternative financing option to a traditional loan.

A financial lease has other advantages in that it makes it particularly easy to replace worn-out equipment. It is also possible to write off lease rates, in part or in full, as overhead costs. Then there is the support from the Luxembourg government, which was increased in 2017. This State aid takes the form of tax credits for eligible capital goods used in the European Economic Area, provided that these investments form part of the balance sheet of a Luxembourg institution.

Note that a financial leasing is no longer systematically considered an off-balance sheet operation. Although they are not legally, the lessee is deemed to be the owner of the asset from an accounting point of view in various situations. The item is shown in the assets in the balance sheet and is depreciated as if the lessee were the owner and VAT is due on the monthly lease payments made to the lessor.

If it is nevertheless the lessor who is considered the economic and fiscal owner according to the criteria set by the legislator, then the lessee does not have the asset on its commercial balance sheet. This reduces the apparent indebtedness of the company and leaves room for other short-term financing if required.

There is only one real disadvantage to having different types of leasing, and that is that this type of financing incurs costs.

There is only one real disadvantage to having different types of leasing, and that is that this type of financing incurs costs. This is why it is particularly important to take a close look at different offers and conditions available before entering into a contract and, if necessary, seek advice from an expert.