Property leasing is a contractual technique used to obtain medium or long-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 immovable assets for business use with a view to leasing them for a specific period 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.
Property leasing may come in the form of a capital lease or an operating lease. A capital lease covers only the financing of the property. An operating lease, on the other hand, contains a financial component as well as a service or maintenance component.
Objective: property leasing is used to finance the purchase of previously developed land, existing buildings or buildings to be constructed, parts of a building, commercial buildings and offices, production areas, industrial and storage buildings, or movable assets which have become immovable by affixation.
Who is concerned
Available to the self-employed and any type of business, property leasing applies in the following cases:
- acquisition of land and/or buildings;
- occupation of new offices;
- refinancing of movable assets by leasing to free up capital for other investments;
- improvement of the balance sheet structure by replacing bank debt with off-balance sheet 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;
calculation of feasibility and return and calculation of the breakeven point;
land: preliminary sale agreement, cadastral map, building permit;
building: preliminary sale agreement, construction plan, building permit, specifications, quotes, photos (if any), lease, etc.;
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 commitment to purchase the building at the end of the lease contract or even during the lease contract;
- 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 bank should be provided with the details of their financial situation.
How to proceed
Duration and amount
The term of the property 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 property leasing, a long-term period is the most common (about 20 years for immovable 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 20 % 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 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:
With purchase option:
When the conditions required for capital leasing are not met, ownership of the asset is allocated to the lessor, unless the possibility of both increases and decreases in the value of the asset is assumed by the lessee.
Therefore, if the lessee only benefits from the chances of an increase in value or only bears the risks of depreciation, legal ownership should not be separated from economic ownership and so the asset is allocated to the lessor and the contract is deemed to be a rental contract.
Treatment of land
Since land cannot be depreciated, the criteria applicable to property leasing to determine tax ownership according to the normal useful life cannot be applied as such:
- where there is no purchase option, land is allocated to the lessor;
- where there is a purchase option, land is treated in the same way as the buildings.
Property leasing is not subject to the payment of registration fees if all of the following conditions are met:
- the lessee uses the asset for business purposes;
- the lease contract is concluded for a fixed term;
- the rental payments are subject to VAT.
However, if the purchase option is exercised by the lessee at the end of the lease contract, transfer duties will be payable on the price stated in the lease contract, plus the rental payments made during the rental period, or on the building’s market value, if higher.
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, but given the complexity of such a transaction, this form of financing is to be considered at the same level as bank financing;
- financial costs are spread over the economic life of the investment;
- cost savings (immediate registration fee, notary, etc.);
- VAT (calculated on the rental payments) is fully refundable.
- lessee can easily become the legal owner at the end of the lease contract without having to raise a large sum at a specific time.
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 purchase, the final cost can be higher;
- payment of transfer duties with respect to property leasing is deferred to the date on which the purchase option is exercised;
- 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 property 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.
- property leasing can be classified as:
- capital leasing: in this case it is often the lessee that records the assets on the asset side of the balance sheet and depreciates them for tax purposes;
- operating leasing: in this case it is often the lessor that records the assets on the asset side of the balance sheet and depreciates them. The lessee enters rental payments in the accounts as an expense.