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Financing Options

The below information is general in nature and does not take into account any individual circumstances. It assumes that the equipment is 100% used in the production of taxable income i.e. there is no “personal use” as defined by the ATO, that the equipment user is registered for GST at all times, accounts for GST on a non-cash basis, and that the ATO’s Small Business Entity Simplified Depreciation Rules do not apply.

Note some accounting concepts have been simplified for explanatory purposes and this is not to be construed as financial advice. We recommend that anyone making a decision in regard to purchase of capital equipment consults with their accountant.

What Financing Options do Businesses Have When Purchasing Equipment?

There are a number of ways in which businesses can finance capital equipment, each of which have their own advantages and disadvantages. We have summarised some of the more commonly used options below.

Outright Purchase

Who owns the asset?

The equipment user owns the equipment at all times.

How is it recorded in the accounts of the business?

The initial purchase is recorded as an asset. There is no associated liability (assuming the business uses its own cash to effect the purchase).

Subsequently, the asset is depreciated over its useful life. Entries are recorded to Depreciation Expense in the Profit & Loss Statement at the end of each period, and a corresponding reduction in the value of the asset on the Balance Sheet is recorded.

How is GST treated?

Assuming the vendor is registered for GST, the equipment user will pay GST at the time of purchase and can claim it back on their next Business Activity Statement.

Depreciation Expense is not a taxable supply so there are no further GST effects.

What are the tax implications?

The equipment user is entitled to claim the decline in value of the asset (i.e. the total depreciation expense incurred in the financial year) as a deduction on their income tax return.

Advantages

  • Simplest of all financing options
  • User owns the goods
  • Does not incur financing costs
  • Depreciation expense is tax deductible

Disadvantages

  • Ties up cash which may be better spent elsewhere in the business
  • Tax deductions limited to depreciation expense only
  • User is responsible for disposing of the asset at the end of its useful life

Chattel Mortgage

Who owns the asset?

The equipment user owns the equipment at all times.

How is it recorded in the accounts of the business?

The initial purchase is recorded as an asset. The principal amount of the chattel mortgage is recorded as a liability.

Subsequently, the asset is depreciated over its useful life. Entries are recorded to Depreciation Expense in the Profit & Loss Statement at the end of each period, and a corresponding reduction in the value of the asset on the Balance Sheet is recorded.

The balance sheet value of the chattel mortgage is reduced by the principal component of each periodic repayment. The interest component of the periodic repayment is recorded as Interest Expense in the Profit & Loss Statement.

How is GST treated?

Assuming the vendor is registered for GST, the equipment user will pay GST at the time of purchase and can claim that back on their next Business Activity Statement. Chattel mortgages are sometimes funded inclusive of GST, sometimes exclusive, and sometimes are structured such that the GST component of the purchase is repaid at the third or fourth payment.

Neither Interest Expense nor Depreciation Expense are taxable supplies so there are no further GST effects.

What are the tax implications?

The equipment user is entitled to claim the decline in value of the asset (i.e. the total depreciation expense incurred) in the financial year as a deduction on their income tax return, as well as the total Interest Expense incurred.

Advantages

  • Depreciation expense and interest expense are both tax deductible
  • User owns the goods
  • Get the benefit of the equipment without having to find the money upfront

Disadvantages

  • Reduces percentage of equity on balance sheet which may negatively impact financial covenants
  • Cash deposit or collateral security may be required depending on the nature of the equipment
  • User is responsible for disposing of the asset at the end of its useful life

Commercial Hire Purchase

Who owns the asset?

Legally, the financier owns the equipment from the time of inception of the CHP contract until the time the last payment is made. The equipment user “purchases” the equipment in instalments via regular monthly payments.

How is it recorded in the accounts of the business?

Although legally the financier owns the asset until the last payment is made, the equipment user is still required to record the asset and the liability in their Balance Sheet. The amount recorded on both sides of the Balance Sheet is to be the present value of the minimum lease payments, discounted at the rate implied in the lease.

Subsequently, the asset is depreciated over its useful life. Entries are recorded to Depreciation Expense in the Profit & Loss Statement at the end of each period, and a corresponding reduction in the value of the leased asset on the Balance Sheet is recorded.

The Balance Sheet value of the CHP contract is reduced by the principal component of each periodic repayment. The finance charge component of the periodic repayment is recorded as Finance Charges in the Profit & Loss Statement.

How is GST treated?

Note: this changed on 1 July 2012 and does not apply to CHP contracts entered into before this date

GST is now levied on all charges relating to the CHP contract, including the initial price of the goods and all interest charges, even if the credit component is separately disclosed. GST is claimable on the entire amount of interest payable over the term of the contract at the inception of the contract, as well as the GST component of the purchase price.

What are the tax implications?

The equipment user is entitled to claim the decline in value of the asset (i.e. the total depreciation expense incurred) in the financial year as a deduction on their income tax return, as well as the total Interest Expense incurred.

Advantages

  • Depreciation expense and interest expense are both tax deductible
  • Get the benefit of the equipment without having to find the money upfront

Disadvantages

  • Reduces percentage of equity on balance sheet which may negatively impact financial covenants
  • Cash deposit or collateral security may be required depending on the nature of the equipment
  • User is responsible for disposing of the asset at the end of its useful life
  • Interest Expense on Commercial Hire Purchase contracts attracts GST

Rental Agreement

Who owns the asset?

Legally, the financier owns the equipment. There is no contractual right for the user to purchase or otherwise obtain ownership of the goods at the end of the term, although most financiers will allow the lessee to “purchase” the goods at the end of the term in exchange for payment of the equivalent of 1-3 rental payments.

How is it recorded in the accounts of the business?

Neither an asset nor a liability are recorded on the Balance Sheet of the equipment user.

The full amount of the periodic rental instalments are recorded to the Profit & Loss Statement.

How is GST treated?

Because the asset is not owned by the equipment user but by the financier, the GST refund on the initial purchase is claimed by the financier.

GST is levied on each of the periodic rental instalments and can be claimed back by the user with each BAS.

What are the tax implications?

The equipment user is entitled to claim an income tax deduction on the total rental instalments paid in a given financial year.

Advantages

  • The entire rental instalment is tax deductible
  • Get the benefit of the equipment without having to find the money upfront
  • Disposal of the equipment at the end of its useful life is the responsibility of the financier
  • A much wider range of equipment can be financed compared to a chattel mortgage or CHP, including smaller dollar values and equipment with short useful life
  • Does not require collateral security

Disadvantages

  • User does not own the goods and is contractually obliged to maintain the equipment in good condition
  • Equipment must be delivered back to the financier at the end of the term at the user’s cost (if the user does not want to purchase the goods or extend the rental period)