What is financial leasing?

Many companies opt for leasing rather than standard borrowing because it offers them an opportunity to replace the moveable capital equipment they use in their workplace without having to eat into their equity capital to do it. Interested? Read on to find out more.

What is leasing?

Maybe a better question would be “What are the various types of leasing?” Financial leasing is far from the only type of leasing available to companies. That’s why it’s important to distinguish between the following:

• • Financial leasing. This is a leasing contract that allows a professional to finance movable equipment in exchange for the payment of rent. The rental period is irrevocable, and the lessee can exercise a purchase option at the end of the contract.
  • Operational leasing. This a leasing contract that allows a professional to lease the item and also benefit from various services. In the case of a car, for example, an operational lease may include vehicle insurance and maintenance for the entire term of the lease. This type of plan does not normally include a purchase option at the end of the lease period.
  • Property leasing. Very marginal in Luxembourg, this is a formula for financing a property for professional use via the payment of rents and with an option to purchase at the end of the contract.

In this article, we will focus on financial leasing. This financing solution is aimed at all types of business (SMEs, large companies, the self-employed and the self-employed) looking to optimise their investments.

What equipment can you finance?

A financial lease is an agreement for the lease of moveable capital goods for professional use. The moveable goods in question can range from a vehicle (car, utility vehicle, van, trailer, bus, etc.) to manufacturing, civil engineering, office and commercial equipment. Medical and IT equipment can also be leased.

How does financial leasing work?

Every financial institution has its own specific processes, but we can still describe how a typical financial lease works in Luxembourg.

In principle, it’s up to you to select your equipment and supplier. Once you’ve made your choice, the selected leasing company buys the equipment and retains ownership of it. It then leases the equipment to you or allows you to use it for a set period of time in exchange for a lease payment. Lease charges can be monthly, quarterly, half-yearly or annual.

At the end of the leasing period, the professional will have paid a significant proportion of the purchase price of the leased property (including costs). If they decide to exercise the purchase option, they will only need to pay the residual value of the asset in order to become its full owner.

At the end of the agreement, you have three options:

• • Purchase the equipment at the initially agreed residual value;
  • Extend the lease;
  • Return the equipment to the lessor and potentially enter into an agreement relating to new equipment.

This financing solution enables lessees to preserve their cash flow while taking advantage of an alternative to traditional credit.

What are the advantages?

One of the main advantages is, of course, the fact that the lessor will finance the equipment in full (including paying all VAT up front) and charge you a pre-agreed fixed lease payment for the entire period of use of the asset. This financing solution enables lessees to preserve their cash flow while taking advantage of an alternative to traditional credit.

Financial leasing also enables you to:

• • Easily replace old equipment;
  • Spreading of the costs over the entire rental period;
  • Partially or fully deduct lease payments as operating expenses;
  • staggered payment of VAT throughout the term of the contract;
  • the possibility of taking advantage, under certain conditions, of a tax credit for investment (art. 152 bis LIR).

Note that financial leasing is no longer systematically considered as an off-balance sheet transaction. Although the lessee is not the legal owner of the asset, he or she may be considered to be the owner from an economic point of view, depending on the purchase option chosen and the duration of the lease (see conditions).

If the lessee is considered to be the economic owner, the asset must appear as an asset on the company’s balance sheet. This will enable the lessee to deduct depreciation and interest as operating expenses for tax purposes.

If the lessor is considered to be the economic and tax owner according to the criteria laid down by the legislator, then the lessee will not include the asset on its commercial balance sheet. He will then be able to deduct the rent as an operating expense for tax purposes. This will reduce the company’s apparent indebtedness and leave room for other short-term financing if required.

It’s important to take the time to properly consider all of the products available to you before picking the one that suits you best. Once a lease has been signed, it’s very hard to amend it.

What are the disadvantages?

There are no real disadvantages to opting for a lease, other than the fact that all financial solutions come with a price tag. However, it’s important to take the time to properly consider all of the products available to you before picking the one that suits you best. Once a lease has been signed, it’s very hard to switch to another product that would be better suited to your circumstances. We recommend discussing it with your banking adviser. They understand your line of business and will be able to point you in the right direction.

We wish you and your company all the very best.