Updated–The great entrepreneurial debate: whether to buy or lease a company vehicle
As Chartered Professional Accountants, the most common two questions we’re asked by clients is whether they should buy or lease a car, and whether they should buy personally or under their company name.
Inevitably our answer has been, “It all depends.” How long do you plan to hold on to the car? Do you have excess cash readily available in your business or personally? Do you plan to put a lot of mileage on the car?
To answer this question, it’s best to address the qualitative and quantitative factors.
On the qualitative side, if you plan to use your car a great deal and will accumulate significant mileage, then owning is the way to go. This way you avoid mileage limits on leases. If, on the other hand, you prefer to drive a brand-new car every few years, then leasing is the best approach. All leased vehicles come with warranties for a specified number of years, as well as annual mileage limits. The leasing term often covers the warranty period, so major repairs and some maintenance is usually covered by the manufacturer. However, when you purchase your vehicle, the holding period tends to exceed the manufacturer’s warranty period, necessitating the need to purchase an extended warranty or take on the risk of paying for expensive repairs.
If cash flow is a concern—and isn’t it always for most small and medium-sized businesses?—then leasing a car will typically mean lower monthly payments compared to financing a car under the same terms. With a lease, you’re only financing a portion of the total cost of the vehicle, often up to a maximum of 70 per cent. The decision to lease or buy usually comes down to lifestyle and how you prefer to pay for the goods you buy. There is also that intangible “pride of ownership” on a purchase that you don’t get with a lease.
In addition, if you own the car you can customize it anyway you like—with company decals, for example—which is not the case with a lease. A leased vehicle must be returned to the leasing company in the same condition as it went out. Also, if you financed the purchase of the vehicle, you will likely have built up equity in the end to help fund a new purchase, which is also not the case when leasing.
To own through a corporation or personally? That is the question
You’re generally better off owning or leasing a vehicle individually rather than through a corporation. The reason is that, according to Canadian tax rules, when a passenger vehicle is owned or leased through a corporation, the individual must report a taxable benefit called a standby charge based on 24 per cent of the original cost of the vehicle or two-thirds of the lease cost. Further, as the car depreciates in value, you’re still taxed on the benefit based on the original cost. Added to that is a further benefit based on the operation costs of the vehicle.
Having said that, if the vehicle is used more than 50 per cent of the time for business or employment purposes, there would be a reduced overall taxable benefit, which would make the personal tax less onerous and, considering other factors, could favour corporate ownership.
For example, a $50,000 employer-owned car driven a total of 20,000 kilometres—of which 15,000 kilometers was for business use, and where the company paid for all operating costs—would generate a taxable benefit of $4,400. The same car driven 9,000 kilometres for business use would produce a $15,080 taxable benefit. (Includes the standby charge and the operating cost benefits. The fixed rate for operating cost benefit calculation in 2019 is 28 cents per kilometer of personal use (2018- 26 cents per km))
Important qualitative considerations
In general terms, leasing a car will have lower monthly payments compared to financing a car with the same loan terms. The reason is that with a lease, you’re paying for the depreciation of the car during those years, rather than the whole vehicle cost.
To determine which option works best, we need to calculate the after-tax cost of purchasing vs. leasing a vehicle.
Continuing with our example, assume the company took out a $50,000 loan over four years to purchase the vehicle. The Income Tax Act only allows taxpayers to write off a maximum of $30,000 plus HST, and in the case of a lease, a maximum of $800 a month.
With the introduction of the federal government’s Bill C-97 in April 2019, the tax measures announced in the November 2018, fall economic statement are now substantively enacted. Most notably, the new Accelerated Investment Incentive (AII) is now legislated for financial reporting purposes. Without going into the nitty gritty of the AII, these measures provide for an accelerated capital cost allowance (CCA) in the first year of purchase provided the vehicle is acquired after November 20, 2018, and available for use before 2028. Essentially, these measures will allow for three times the CCA normally allowed in the first year. Overall, the larger deduction taken in the first year will generally result in smaller CCA deductions in future years.
In this case, the maximum CCA (tax depreciation) the company would incur over four years under the new AII will be $27,505, with an interest expense of approximately $3,000. This would generate approximate of $4,570 in corporate tax savings. Assuming a residual value of $20,000, the after-tax cost of the vehicle would be $28,400.
The lease cost for the same vehicle is $35,000 over four years and would generate $5,250 in corporate tax savings, or an after-tax cost of $29,750. If you have the cash and don’t have to worry about bank financing, you should buy the vehicle outright, thereby allowing you to own the asset and incur as much mileage as desired. Consider leasing if you don’t have the cash to buy up front, or if you want lower monthly payments and are a low-mileage driver.
Overall, we generally recommend that vehicles should be leased or purchased personally. While you may be saddled with the HST, the taxable benefits associated with company-owned or leased vehicles can be onerous. The big advantage of using your personal vehicle for business is that under certain circumstances, your company can reimburse you tax-free by paying a reasonable car allowance, which can be used to cover any personal carrying costs you may incur.
It’s clear there are both pros and cons of purchasing and leasing a vehicle, and the choice may come down to personal tastes and priorities rather than dollars and cents. Each individual situation is different, so be sure to discuss your specific financial and tax circumstances with your tax or financial advisors before making any decisions.
Hartley Cohen, Partner
Hari Krishnan, Senior Tax Associate