The short answer
A finance lease is an agreement where the lender, called the lessor, buys a vehicle or piece of equipment and leases it to your business for a fixed term in return for regular rental payments. At the end, a pre-agreed residual value is due, which you can pay to take ownership, refinance, or cover by selling or trading the asset. The lessor owns the asset throughout, so your business doesn't claim depreciation on it. Instead, lease payments are generally deductible to the extent the asset is used for business. GST works differently from a purchase. Each lease payment includes GST, and a registered business claims the credit on each activity statement as it pays, instead of upfront (ATO). Terms usually run from two to five years. Vehicle leases carry minimum residual values tied to the term, while equipment leases are more flexible. A finance lease differs from an operating lease, where the lessor takes back the asset.
How does a finance lease work?
- You choose the asset, and the lessor buys it from the supplier.
- Your business leases it for an agreed term, usually two to five years, with fixed monthly rentals.
- At the end, the residual value falls due.
- You pay the residual and take ownership, refinance it into a new lease or loan, or sell or trade the asset to cover it.
Under a finance lease your business carries the residual risk. If the asset is worth less than the residual at the end, you make up the difference.
How do GST and deductions work?
The ATO treats each lease payment as a separate supply. GST is included in every rental, and a registered business claims the GST credit on the activity statement for the period it pays. There's no large upfront credit as there is with a chattel mortgage.
Because the lessor owns the asset, the lessor claims depreciation. Your business generally deducts the lease payments to the extent the asset is used to earn income. Leases of cars costing more than the car limit are treated differently, as a notional sale and loan, so ask your accountant before leasing a more expensive car.
What residual values apply?
For vehicle leases, lessors apply minimum residuals based on the lease term. The schedule widely used by lease providers is:
| Lease term | Minimum residual (% of cost) |
|---|---|
| 1 year | 65.63% |
| 2 years | 56.25% |
| 3 years | 46.88% |
| 4 years | 37.50% |
| 5 years | 28.13% |
Equipment leases generally have more flexibility on the residual. Your lessor confirms the residual for your lease before you sign.
Finance lease, operating lease or rental?
| Option | Residual risk | At the end | Suits |
|---|---|---|---|
| Finance lease | Your business | Pay, refinance or trade the residual | Vehicles and equipment you may want to keep |
| Operating lease | The lessor | Return the asset or extend | Fleets and assets replaced on a cycle |
| Rental | The lessor | Return, upgrade or keep renting | Technology and assets that date quickly |
When does a finance lease make sense?
A finance lease can suit a business that prefers GST spread across payments instead of a lump-sum credit, wants predictable rentals that are generally fully deductible for business use, or plans to replace the asset at the end of the term. Businesses that want ownership from day one and the upfront GST credit usually prefer a chattel mortgage.
