Leasing - Fiscal implications

Leasing is a medium or long term contractual credit technique whereby a leasing company (the lessor or licensor), on request by and in accordance with the specifications of its client (the lessee or licensee), acquires full ownership of movable or immovable assets for business use with a view to leasing them to the client for a specific period and in exchange for fees or lease payments.

At the end of the fixed period, the lessee generally has several options. He may:

  • return the asset to the leasing company;
  • ask for the lease contract to be renewed;
  • purchase the asset at a price which takes into account, at least partially, the lease payments already carried out.

There are different forms of leasing depending on the type of asset required by the company, its financial possibilities and the level of responsibility it wishes to engage: Each form of leasing has a different fiscal implications.

Who is concerned

Any business may resort to leasing. Leasing can complete or replace the classic ways of business financing, i.e. through equity capital (or shareholders' equity) or loan capital, and it represents an alternative to the direct purchase of fixed assets.

How to proceed

Tax impact of leasing

From a fiscal point of view, leasing has several advantages.

The payment of VAT is spread over the full lease term and VAT is pre-financed by the leasing company.

Leasing may give access to tax deductions. There are 2 possible scenarios:

  • the lessee is the tax owner of the asset. In this case, the asset is shown in the assets of the lessee's balance sheet and the lease payments are broken into 2 parts:
    • a part made up of the interest, which is deductible from the user's tax base;
    • a part made up of debt repayments, which is non-deductible.
  • the lessee is not the tax owner of the asset: lease payments are fully tax deductible from its tax base.

Tax ownership is determined according to the type of lease contract.

Capital leasing

Characteristics

Capital leasing is the most common financing technique for investments in capital assets. It enables the business to invest without impacting its cash flow. Capital leasing consists in:

  • upon request from the lessee, a lessor purchases an item from a provider selected by the lessee;
  • the lessor signs a lease contract with the lessee for a fixed period of time during which the lessee may use the item and in return must pay a monthly lease to the lessor.

During this period of time, the basic lease term is irrevocable for both parties and:

  • the lessee pays the full purchase price or cost price, the incidental expenses and financing fees;
  • from an accounting point of view, the lessee is deemed to be the owner of the asset although legally he is not. 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;
  • the lessee is deemed to be the economic owner of the asset as regards income tax (income tax (IR) or corporate income tax (IRC)).

At the end of the contract, the lessee has several options:

  • purchase the leased asset at a predetermined price (residual value);
  • extend the lease contract;
  • return the asset to the lessor.

As the lessee pays the full purchase cost of the asset (including interest) during the basic lease term, the purchase of the asset at the end of the contract is very likely as the cost of the purchase option is very low.

NB: a company car purchased by an employee at a price which is lower than the market value is considered to be a non-periodical remuneration by the Luxembourg Inland Revenue (ACD) and will be taxed at the moment of purchase.

The determination of tax ownership depends on the possibility to purchase the leased asset.

Lease contracts without purchase option

Where a lease contract is concluded without purchase option, the tax ownership will be allocated depending on the duration of the basic lease term:

  • it will be allocated to the lessor if the lease term is between 40 % and 90 % of the normal life of the asset;
  • it will be allocated to the lessee:
    • if the lease term is less than 40 % of the normal life of the asset;
    • or greater than 90 % of the normal life of the asset.

Duration of basic lease term = Duration of lease term / Duration of useful life of asset x 100

Example : a company car is leased by a company for its employee.

Useful life: 4 years (48 months)

Contract conditions:

  • initial price for the car: EUR 20,000;
  • irrevocable duration of lease term: 43 months;
  • lease payments: EUR 560 per month;
  • without purchase option.

The conditions for capital leasing are met.

Duration of basic lease term = 43 / 48 x 100 = 89.58 %

Since the basic (irrevocable) lease term is less than 90 % of the asset’s useful life, the car is allocated to the lessor.

Lease contracts with a purchase option

Where the contract is concluded with a purchase option, the tax ownership is allocated to the lessee if the following 2 conditions are met:

  • the basic lease term is between 40 % and 90 % of the normal life of the asset;
  • the price for the option is:
    • higher than the asset's book value;
    • or lower than its estimated realisation value.

Tax ownership is allocated to the lessor in every other case.

Book value = Price of the asset – Depreciation

Depreciation = Price of the asset / Duration of fiscal life

Example: a company car is leased by a company for its employee.

Useful life: 4 years (48 months)

Contract conditions:

  • initial price for the car: EUR 20,000;
  • duration of lease term: 43 months;
  • lease payments: EUR 560 per month;
  • purchase option: EUR 2,000.

The cost of the purchase option represents 10 % of the assets value if new (initial price).

  • depreciation = 20,000 / 48 = EUR 416.66;
  • book value = 20,000 - 416.66 = EUR 19,583.34.
=> Since the price of the option (10 % of the new value) is lower than the book value of the asset determined according to the straight-line depreciation value (which is 43 / 48 = 89.58 %, i.e. 100 - 89.58 = 10.42 % of the purchase price after 43 months), the asset (car) is allocated to the lessee.

Operating leasing

Definition

Operating leasing is a means to finance medium term regular investment projects such as a vehicle fleet (cars, vans, trucks, boats and planes), production tools, equipment or machinery and other movable assets (computers, printers, photocopiers, etc.).

It also often contains a service or maintenance component, i.e. in addition to the financing component, the contract contains additional services, such as the maintenance of the asset, insurance and repairs, etc.

Le lessee is simply renting movable assets, also from an economic standpoint.

Characteristics

The contract is similar to a rental contract and does not include a purchase option (the purchase may be negotiated at the end of the contract).

The leased item is returned to the lessor at the end of the contract, according to the precise terms defined and agreed upon at the time the contract was concluded.

The risks are limited for the lessee who is not the owner of the asset and therefore does not have the same rights and obligations inherent to ownership.

The lessee has no other obligation. The sale of the asset is deemed to be undertaken by the leasing company.

Tax impact

the lessee is the tax owner of the asset.

He will be granted a tax credit on the grounds of investments. The tax credit amounts to:

  • 6 % for the first tranche of investments which does not exceed EUR 150,000;
  • 2 % for higher tranches.

The lessee is liable for VAT on lease payments. VAT is fully recoverable.

Property leasing

Characteristics

Property leasing is a means to finance the purchase and, sometimes, the construction of immovable assets which includes constructed land, existing buildings or still to be built, parts of buildings, commercial buildings and offices, manufacturing and industrial buildings, storage depots, movable assets which have become immovable assets through incorporation.

The lessor commits himself to purchase or to construct a building for business use and to provide enjoyment of said property to his contracting partner (e.g. via a long term lease).

Property leasing has the advantage in that it does not block the capital, nor does it reduce the balance sheet result. The lessee in property leasing receives the right of long term use. The contract must stipulate what will happen to the property at the end of the term. The lessee may or may not benefit from a purchase option on the asset. Registration fees are deferred, where applicable, to the day the purchase option is exercised.

Tax impact

Tax ownership of the building is allocated to the lessee.

Tax ownership of the land is determined depending on whether there is a purchase option on the asset leased:

  • the contract is concluded without purchase option: the land is allocated to the lessor;
  • the contract is concluded with a purchase option: the land is allocated to the lessee.

In the event the lessee exercices the purchase option, he must pay transfer duties to the Indirect Tax Authority. The transfer duties consist of 2 elements:

  • a registration fee of 6 %;
  • and a transaction fee of 1 %.

A communal surcharge of 50 %  will apply if the building is located on the territory of the Luxembourg commune.

Transfer duties apply to the highest of the following 2 amounts:

  • the contractual purchase price + the lease payments carried out during the lease term;
  • and the market value of the building.
Example: a lease of 5 years with annual lease payments of EUR 100; purchase option: EUR 300; market value on the day the option is exercised: EUR 700.
The lease payments over 5 years (5 x EUR 100) plus the purchase price (EUR 300) amount to EUR 800. This amount is higher than the market value of the building (EUR 700).
=> In view of this, the transfer duties are levied on the amount of EUR 800 and not EUR 700.

Property leasing is not subject to the payment of proportional 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;
  • and the lease payments are subject to VAT.

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