Introduction
In the last number of years the use of leases in farming operations has become more and more prevalent. Statistics from Farm Credit Corporation indicate that the annual percentage increase in the volume of leases from 2010 to 2012 was 34%, 66% and 14% respectively with an average increase of 38% in the last three years.
While the leasing of farm land in a farming operation may come to mind first, this article will focus on the leasing of farm equipment and even farm buildings such as granaries.
A lease is defined as a written agreement under which a property owner allows a lessee to use the property for a specified period of time and rent. Generally, we refer to two types of leases; operating leases and capital leases. While the type of lease does not affect the tax treatment of the lease payments, it can affect financial statement presentation which will be discussed later.
Leasing assets can be done for a variety of reasons including as a financing tool, providing the ability to keep your assets up to date, keeping a consistent cash flow, reducing or at least deferring tax or to simplify the process of acquiring the equipment.
Tax Treatment
Lease payments are generally fully deductible for tax purposes. This differs from the purchase of equipment where the tax deductible portion become the capital cost allowance (CCA) plus interest if you have financed the purchase. CCA is also limited in the year of acquisition to one half the normal rate.
A simple example of this is as follows:
At the end of June Farmer A needs a new tractor. He has the option of purchasing or leasing. The tractor will cost $100,000. He will have to finance 100% of the purchase and he is able to do so over five years at 4% which will give him a monthly payment of $1,842. The tractor is a class 10 asset which has a CCA rate of 30%. However, in the year of purchase, Farmer A will only get one half that rate or 15%.
If the purchase happens on July 1st, Farmer A will get the following deductions in year one:
| CCA ($100,000 * 15%) | 15,000 |
| Interest | 1,924 |
| Total deduction (year one) | 16,924 |
If Farmer A leases the tractor and the payments are the same as his loan payments then his tax deduction will be:
| $1,842 * 6 | 11,052 |
In this case, from strictly a tax perspective, the lease would be less effective than the purchase in year one.
If, however, the equipment is purchased/leased right at the beginning of the year, the result would be as follows:
| CCA ($100,000 * 15%) | 15,000 |
| Interest | 3,664 |
| Total deduction (year one) | 18,664 |
| Total lease payments | |
| $1,842 * 12 | 22,104 |
| Increased tax deduction by leasing | 3,440 |
From this example it is evident that changing the parameters, including the length of the lease term, timing of the payments or interest rate can affect the decision. Generally, in year one, purchasing an asset at or near the end of the year provides a faster write-off for tax purposes.
What if the piece of equipment changes from a tractor to an air seeder? This changes the CCA class to class 8 which has a rate of 20 % (10% in year one). If we again use the example of acquiring the equipment in January, the result would be as follows:
| CCA ($100,000 * 10%) | 10,000 |
| Interest | 3,664 |
| Total deduction (year one) | 13,664 |
| Total lease payments | |
| $1,842 * 12 | 22,104 |
| Increased tax deduction by leasing | 8,440 |
Currently, an option that exists with some financial institutions is the ability to lease grain bins. Once again the parameters change as grain bins are considered by Canada Revenue Agency (CRA) to be class 6 assets with a CCA rate of 10% (5% in the year of purchase). If the bin cost $40,000 with terms similar to those above the monthly payments would be $737. If the bin were purchased/leased on July 1 the results are as follows:
| CCA ($40,000 * 5%) | 2,000 |
| Interest | 770 |
| Total deduction (year one) | 2,770 |
If Farmer A leases the bin and the payments are the same as his loan payments then his tax deduction will be:
| $737 * 6 | 4,442 |
It is evident form the examples above that each situation from a tax and cash flow standpoint will change based on the variables. Your Collins Barrow advisor can help with this analysis.
Prepaid Lease Payments
Cash base farmers have the ability to deduct expenses when paid in the current year, provided the payments do not relate to a taxation year two or more years after the year of payment. One possible use of this provision would be in the trade in of an existing piece of equipment, followed by the lease of the equipment used to replace it.
For example, on September 1, 2013 Farmer Jones trades in a self-propelled combine with a value of $100,000 and an original cost of $250,000 and uses the $100,000 trade-in value as a down payment on the first 36 months of a 60 month lease with monthly payments of $4,000 commencing on September 1, 2013.
The results of this transaction would be as follows:
The Class 10 pool of assets would be reduced by the trade-in value of $100,000.
Lease payments of $64,000 ($4,000 per month for 16 months to the end of 2014) would be deductible on the trade-in, providing a more significant write-off in year one.
Accounting treatment of Leased Assets
As previously mentioned, lease payments are deductible for tax purposes. The accounting treatment, however, may not be as straight forward.
Leases can be categorized as either capital leases or operating leases. For accounting purposes there are certain tests to be met which will determine which type of lease it is. A lease is considered to be a capital lease if it really appears to be a way to finance the purchase of the equipment. For example, there may be a very favorable bargain purchase option at the end of the lease.
If it is determined that the lease is capital the asset will be set up on the financial statements along with the related debt (referred to as a capital lease obligation) similar to any financing arrangement. Interest implicit in the lease payments will be expensed and the assets will be amortized along with other purchased assets. When the tax return is prepared the interest and amortization will not be deductible but rather the expense will still be the actual lease payments made in the year.
If the lease is determined to be an operating lease the lease payments will be considered an expense on the financial statements as well as for tax purposes.
GST
While there is no GST on the purchase of many types of agricultural equipment, there is GST on the lease payments. While this GST is recoverable as an input tax credit when the lease payments are made it does present additional cash flow considerations. This differs from the purchase of a piece of equipment where the GST paid is generally recovered at the time of purchase.
Passenger Vehicles
There are certain limitations with respect to the purchase or lease of a passenger vehicle. A passenger vehicle is an automobile that carries passengers in excess of the driver and two other passengers (for example an extended-cab truck). While the determination of whether the vehicle is restricted under the rules relating to passenger vehicle is beyond the scope of this article, it is important to remember that leasing the vehicle will not preclude the taxpayer from these rules.
Conclusion
Leasing farm assets is becoming more and more common. While there are many tax reasons that may drive the decision to lease, one should consider all tax and non-tax information before making a final determination. Your Collins Barrow advisor can assist you in evaluating the lease versus buy decision.
Rob Fischer, CA, is a partner in the Red Deer office of Collins Barrow.