Capital leasing is a contractual technique used to obtain medium-term credit whereby a leasing company (the lessor), at the request and according to the specifications of its client (the lessee), acquires full ownership of movable assets for business use with a view to leasing them for a specific period and in exchange for fees or rental payments. The lessee, which, by this means of financing, keeps its financial independence, must maintain the asset in a prudent and responsible manner and ensure that it is adequately insured. At the end of the lease contract, the lessee can:
- return the asset to the lessor, thereby ending its obligations;
- ask for the lease contract to be renewed;
- purchase the asset at the price agreed in the lease contract if there is a purchase option.
During the term of the capital lease, the business pays almost the full purchase cost of the asset, including interest. Therefore, the residual value at which the lessee may purchase the asset at the end of the lease contract is relatively low.
Objective: capital leasing is used to finance the vehicle fleet (cars, vans, trucks, boats and planes), production tools or various machinery and movable assets (computers, printers, photocopiers, etc.).
Who is concerned
Available to the self-employed and any type of business, capital leasing applies in the following cases:
- acquisition of movable assets when a business is being set up;
- refinancing of movable assets by leasing to free up capital for other investments;
- modernisation of production tools, IT system, etc.;
- improvement of the balance sheet structure by replacing bank debt with off-balance sheet capital leases;
- tax optimisation.
Documentation or description of the business
- copy of the company’s articles of association;
- group structure if the company is part of a more complex group;
- last 3 audited balance sheets of the borrower and, if applicable, the latest available trial balance;
- order book (where applicable);
- list of customers and their relative contribution to turnover;
- list of suppliers;
- forecast balance sheet or business plan in the case of a new business activity or a major expansion plan.
Presentation of the project
- detailed description (including figures) of the planned investment;
- financing plan;
- calculation of feasibility and return and calculation of the breakeven point;
- machinery: list of investments, replacement of existing equipment, additional equipment, purchase orders or invoices;
- supplier: contact details, references, brands.
A significant guarantee for the lessor is that it maintains legal ownership of the asset and so the risk incurred is reduced. It may, however, request the following additional guarantees:
- a pledge of a certain amount representing the proportion of shareholders' equity of the investment;
- the payment of a higher first rental payment, also representing the proportion of shareholders' equity of the investment and allowing the leasing company to reduce the level of risk from the start. This first rental payment is generally tax deductible by the lessee;
- a commitment by the supplier of the asset or by the customer to take back or purchase the equipment at the end of the lease contract;
- assignment of a fully comprehensive (casco) or all-risks insurance policy;
- surety of the parent company or partners/shareholders;
- various other tangible and moral guarantees.
When the partners/shareholders of a business have to stand surety for the company, the details of their financial situation must be provided to the leasing company.
How to proceed
Duration and amount
The lease is referred to as a 'capital lease' if the lease contract:
- provides for the transfer of all rights, obligations, advantages, disadvantages and risks associated with the ownership of the asset financed by the lease to the lessee;
- provides for a basic rental period that is irrevocable for both parties;
- guarantees the lessor’s right to recover their capital expenses and to be remunerated for the capital invested, i.e. the lessee is obliged to pay the purchase price or the full cost price of the leased asset, including incidental and financing expenses.
The term of the capital lease is greatly limited by accounting and tax requirements and the economic life of the asset.
Considering the nature of the objects to be financed by capital leasing, a short to medium-term period is the most common (between one and 5 years for movable assets).
Financing of up to 100 % of the asset’s value.
- the rental payments depend on different criteria, including, for example, the quality of the lessee, the amount, the rate, the amortisation period of the asset to be financed, etc.;
- equal rental payments, depending on:
- a fixed or variable interest rate;
- the asset’s residual value;
- administrative charges.
monthly, quarterly, semi-annual or annual rental payments.
The residual value at which the lessee can purchase the asset at the end of the lease contract is generally between one and 10 % of the purchase price. The difference between the residual value and the initial value of the asset is paid in the form of rental payments.
Accounting and tax information
The lessor is the legal owner of the asset during the full lease term.
Economic and tax ownership
Economic ownership and consequently the tax ownership of the leased asset is allocated to either the lessor (legal owner) or the lessee, depending on whether the lease contract provides for a purchase option or not:
Without purchase option:
- asset allocated to the lessor if the lease term is between 40 % and 90 % of the normal life of the asset;
- asset allocated to the lessee if the lease term is less than 40 % or greater than 90 % of the normal life of the asset.
With purchase option:
- asset allocated to the lessor if:
- the lease term is between 40 % and 90 % of the normal life of the asset and
- the price of the purchase option is greater than the book value obtained by applying straight line depreciation;
- asset allocated to the lessee if:
- the lease term is less than 40 % or greater than 90 % of the normal life of the asset and
- the price of the purchase option is lower than the book value obtained by applying straight line depreciation.
Accounting treatment of the asset
The accounting treatment of the asset depends on the economic and tax ownership:
- if the lessor is considered to be the owner: the fixed asset does not appear in the lessee’s commercial balance sheet; only the rental payments are entered in the accounts and are tax deductible as operating expenses;
- if the lessee is considered to be the owner: the fixed asset is recorded on the asset side of the business’ balance sheet. Consequently, it is also the lessee who depreciates the asset. The depreciation and financial interest are tax deductible as operating expenses.
The payment of VAT is spread over the full lease term, with the VAT being pre-financed by the lessor.
The reviewing and processing times depend on the complexity, size and urgency of the case.
Advantages, disadvantages and risks
- can make it easier to obtain financing and thus represents a swift and flexible solution to investment problems without affecting the business’ credit lines or specific guarantees with banks;
- financial costs are spread over the economic life of the investment;
- VAT (calculated on the rental payments) is fully refundable.
If the lessee is the economic and legal owner of the asset:
- depreciation and financial interest are fully deductible from the taxable profit as an operating expense.
If the lessor remains the economic and legal owner of the asset:
- rental payments are fully deductible from the lessee’s taxable profit as an operating expense;
leased assets are not entered in the accounts as fixed assets, thus making budgeting easier.
- compared to a cash payment, the final cost is higher;
- payment of a penalty if the lessee ends the lease contract early.
If the lessee is the economic and legal owner of the asset:
- obligation to record the asset on the asset side of the balance sheet as a fixed asset and to depreciate it for tax purposes.
The main risk with capital leasing is the risk of accounting and tax reclassification. There is no specific legislation in Luxembourg regarding leasing. It is therefore necessary to follow the standards established in a circular of the German tax authorities (and which are used as a basis by the Luxembourg tax authorities) or international accounting standards and request the prior approval of the Luxembourg tax authorities in order to avoid a reclassification.
Capital lease amount
Term of capital lease
Indicative fixed interest rate
Residual value of 10 %
Monthly rental payment (capital & interest)