Financing Cars and Equipment - Lease or Chattel Mortgage?
Our business clients often ask, what’s the best way to finance a car, truck, piece of machinery or equipment for their business?
While there are a number of different finance options, the two most common methods are a lease or a chattel mortgage. In this post I will explain how each method works to help you assess which type of finance might best suit your business situation. For simplicity, I will just refer to financing a car but the same guidelines apply to trucks, machinery and equipment.
Lease First of all, a lease is effectively a rental arrangement where the finance company purchases the vehicle on your behalf and then ‘rents’ the vehicle to you. The GST on the car's purchase price is claimed back by the finance company, so you only finance the GST exclusive price of the vehicle. For example, a new car that costs $55,000 includes $5,000 GST so you only finance $50,000.
The term of the lease can be 12 to 60 months and GST will apply on your monthly lease payments. Provided the asset is used exclusively for business purposes, your monthly lease rental payments are tax deductible and at the end of the lease you will have a residual value to pay. This residual value is a set dollar amount that is a percentage of the amount originally financed. For example, a 20% residual on the $50,000 car will be $10,000. The higher the residual value at the end, the lower the monthly repayments which can assist with cash flow.
At the end of the lease you can either, pay the residual value and take ownership of the car (then sell it or trade it in) or you can re-finance the residual amount and continue the lease.
The second finance option is a chattel mortgage which is more like a loan where you take ownership of the vehicle at the time of purchase and the finance company takes out a ‘mortgage’ over the vehicle as security for the loan. The repayment period is generally between 1 and 5 years and there is an option to have a lump sum balloon payment at the end. The larger the balloon amount the smaller the monthly loan repayments.
The balloon amount is a set dollar amount which is a percentage of the car’s purchase price and the amount will depend on factors such as the age and type of vehicle and the term of the finance. At the end of the finance contract you can re-finance the balloon amount and when the loan is fully paid out, the finance company removes its security over the car giving you clear title so you can sell it or trade it in.
Some other features of a chattel mortgage include the option to pay a deposit or use a trade-in to reduce the loan amount. Your monthly repayments are fixed for the term of the finance contract and no GST is charged on the monthly repayments or the contract balloon amount. Most importantly, if you are registered for GST and use the vehicle exclusively for business purposes, you can claim back the GST on the purchase price when you lodge your next Business Activity Statement. This can obviously provide a significant cash flow advantage.
With a chattel mortgage, you are the effective owner of the vehicle so for tax purposes you can claim a tax deduction for depreciation (up to the depreciation cost price limit which in 2016/17 is $57581) plus the interest on the loan.
In summary, with a chattel mortgage you get a bigger tax deduction in the early years but it reduces each year as the car ages and the depreciation expense diminishes. With a lease, the tax deductible rental payments remain constant over the term of the lease. Ultimately, your choice between the two methods will boil down to your business use of the vehicle, the age of the car, your GST tax status, the type of business structure you operate under and cash flow considerations. So, if you’re looking to finance a car, truck, piece of equipment or machinery we urge you to contact us today. We’ll make sure the finance is structured to produce the best tax and cash flow outcomes for your business. In addition, if you’re looking to buy a new vehicle, through one of our affiliates you can access fleet pricing on new cars and light commercial vans that could save you thousands of dollars.