Last week, we introduced the concept of leasing and talked about its more popular form, the financial lease. By way of review, a financial lease, which we can also refer to as asset lending, is like a loan from a bank to acquire an asset (say, an equipment), backed up by a chattel mortgage. The difference is that the ownership of the asset being financed stays with the lessor even as the lessee pays monthly amortizations. At the end of the lease, ownership of the asset is transferred to the lessee.
Let’s talk about the other type of lease as practiced here in the Philippines: the operating lease. An operating lease is a “true lease,” so to speak, because the lessee pays only for the use of the asset. The asset is not turned over to the lessee at the end of the lease contract.
The lessee however, may want to acquire the asset or equipment at the end of the lease. He or she may do so, by purchasing the equipment at fair market value. An operating lease is commonly used to acquire equipment for use in the short term, say three years.
So, in theory, a high-net-worth individual can easily change his or her car every three years or oftener. The lessee does not have to worry about registration or maintenance and even insurance costs. This setup is also ideal for clients who value their privacy and wouldn’t want the vehicle reflected in their statements of assets, liabilities and net worth.
A more realistic scenario would be a large company that would like to have a fleet of cars for its senior executives, without the hassle of maintaining each and every one of those vehicles.
Bearing the residual value
We again talked to one of the leasing industry’s top players, BDO Leasing and Finance Inc., which offers operating leases through BDO Rental Inc.
Roberto Lapid, vice chairman and president of BDO Leasing, explains that operating leases may allow high-net-worth clients to change their car every three years as long as there’s an ironclad contract with the car dealer to shoulder the vehicle’s residual value at the end of the rental period.
“As long as we have an arrangement with the vendor for us to be able to manage the residual risk then we have that relationship. Otherwise, it’s always a lease-own with our high-net-worth individual,” he explains.
As for maintenance, there’s a third-party maintenance agreement with the supplier. “All our assets…not only vehicles, but also equipment, are covered by comprehensive insurance. So all risks, the so-called ‘acts of God’ including earthquakes, flooding, all of these are covered by insurance,” says Lapid.
Corporations have an additional advantage when it comes to operating leases. They can declare rental payments as expenses, thereby lowering their taxable income, and generating tax savings.
“The client is able to generate a lot of tax savings because his taxable income is lowered in the first three years,” Lapid says. If the client later on decides to get the equipment and carry such in its books, it can then be depreciated for the remainder of its useful life.
For now, operating leases are off the books. By 2019, however, lease accounting rules will change substantially under IFRS-16, which will require companies to recognize most leases, including operating leases, in their books.
Thus, equipment being leased will be recognized as assets, while rental obligations will have to be recorded as liabilities.
BDO Leasing’s Lapid acknowledges that operating leases could lose their appeal as a result. “In fact, in the last two years most of the multinational and local companies are trying to slow down because they’re already preparing for January 2019 on how will they be affected. The auditors are also preparing for that,” he says.
But there’s always financial leasing, the popular choice. Next week, we’ll examine how leasing arrangements can benefit the health sector, especially hospitals that need to upgrade their medical equipment.