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. A financial lease is an agreement for the lease of moveable capital goods for professional use, subject to a fixed lease term at the end of which you will, in principle, have paid the full price of the leased good, as well as any financial and incidental expenses. 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.
- operational leasing in which you 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, where the leased asset is a property. A property lease is a type of property loan granted by a financial institution that doesn’t want to accept liability for any of the risks associated with ownership. However, this type of lease is very rare in Luxembourg because of the country’s unfavourable tax system. Property leases are extended to individuals and we won’t be discussing them in this article.
Instead, we’ll focus on financial leases, which are aimed at companies of all kinds – from independent professionals to shopkeepers to large-scale organisations – that want to optimise their investments.
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 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.
Some financial institutions also allow you to opt for non-linear lease payments that track your cash flows.
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. Some financial institutions also allow you to opt for non-linear lease payments that track your cash flows. This means that you can reduce your cash holdings while also benefiting from an alternative to traditional borrowing.
Financial leasing also enables you to:
- Easily replace old equipment;
- Partially or fully deduct lease payments as operating expenses;
- Benefit from government assistance at the higher rates in place since 2017. This assistance takes the form of a tax rebate on eligible assets used within the EEA, provided that these investments appear on 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.
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.