What is a leaseback and how does it work?
Another name for leaseback that we may encounter is reverse leasing. This term seems a bit clearer, although it is less frequently used. This is because a sale-leaseback is a service that occurs in contrast to a classic lease. Under a reverse lease, an entrepreneur resells a fixed asset, owned by the company, to a leasing company. However, this is not a simple sale, but a transfer of ownership of the object, while retaining the right to use by the previous owner.
The primary benefit of a sale-leaseback is the receipt of funds from the sale of the object. In this way, a company that has spent money to purchase a vehicle, machine or other fixed asset can release those funds while continuing to use the item.
Example:
Mr. Alexander has entered into a contract with a leasing company, under which the lessor becomes the owner of three refrigeration cabinets. However, there is a provision in the contract that the refrigerators will remain at Mr. Alexander’s place of business for the duration of the contract.
This allows Mr. Alexander’s company to operate unchanged, and its account will be credited with the amount from the sale of items.
In the example above, Mr. Alexander is both the buyer of the item and its supplier. The transaction involves him receiving payment from the buyer, thus freeing up the funds he spent to purchase the item. In return, however, he undertakes to pay installments on time.
The term of the contract depends on the value of the asset, the amount of installments and the amount of the buyout, if any – similar to a standard lease.
Leaseback – operating or finance?
Like a classic lease, a sale-leaseback agreement can be entered into as an operating lease or a finance lease.
Operating leases
In this option, the lessor should include the purchased item in the fixed asset register. It is also on him to make depreciation deductions. The entrepreneur achieves a number of tax advantages, such as the ability to include lease installments and expenses for repairs or servicing in deductible expenses. At the end of an operating lease (including a sale-leaseback), the entrepreneur can buy the object again. However, this is not necessary.
Financial Leasing
This option leaves the need for depreciation in the hands of the seller of the asset. What’s more, a finance lease agreement assumes that automatically after the last installment is paid off, the entrepreneur will become the owner of the asset again.
What else is the difference between an operating lease and a finance lease? Which option will prove more beneficial to your business? Read our guide: Operating lease vs. finance lease – learn the differences!
What can be the subject of a leaseback agreement?
As in the case of a classic lease, the object of a sale-leaseback can be almost any fixed asset. The condition is the ability to make depreciation deductions.
Leaseback is most often used to finance sales:
- real estate,
- Vehicles (passenger and commercial),
- construction machinery,
- production machinery,
- agricultural machinery,
- computer hardware,
- medical equipment,
- process lines,
- technical devices,
- land.
Important!
Reverse leases can be used to finance not only the sale, but also the right of perpetual use of land.
Often, the funds raised from the sale of an asset via a sale-leaseback are used to make investments. A flagship example of this is real estate, which is often leased back and the funds raised are used to modernize, expand or retrofit the building that is the subject of the agreement.
What are the benefits of launching a leaseback?
The service in question would not be so popular if it were not for the benefits it brings.
Money injection – the most important benefit of leaseback is, of course, the ability to free up funds frozen in the fixed assets purchased. The seller retains the right to use the machine, vehicle, real estate or other asset, while at the same time gaining access to money that can be spent on any corporate purpose.
Costs of doing business – you can include lease payments and other fees related to the service in deductible expenses, thus reducing the tax base.
No impact on creditworthiness – leaseback allows entrepreneurs to obtain funds without lowering the company’s creditworthiness. The basis for this approach is that the lessee is also the supplier of the financed asset. This works similarly to factoring – financing with factoring also has no impact on creditworthiness, since the object of financing is the entrepreneur’s receivable.
Low financing costs – a derivative, as it were, of the previous point is the relatively low cost of reverse leasing. Compared to working capital loans, investment loans or cash loans for businesses, leasing tends to be more favorable.
Less paperwork and fast implementation – the lessee does not need to provide many documents to the leasing company. A proforma, technical specifications of the subject of the contract, a leasing application and a confirmation of purchase will be needed. In some cases, it is also necessary to provide the lessor with the company’s financial documents and fixed asset records.
Leaseback and VAT and income tax
Like any financial service, leaseback has some downsides. The most significant of these is the need to pay taxes on the asset sold. As revenue is generated on the side of the company, a VAT invoice must be issued to the lessor and PIT or CIT (depending on the type of business) and VAT must be paid.
It should also be borne in mind that if a finance leaseback is chosen, only the interest portion of the advice (without the principal portion) can be included in the entrepreneur’s deductible expenses.
Another inconvenience to consider is the amount limit on depreciation deductions. It is currently set at PLN 150,000. You can read more about depreciation deductions and related rules in our guide: Depreciation of fixed assets – methods and costs.
VAT should not be forgotten. In an operating leaseback, the VAT rate is 23%. Thus, the entrepreneur will pay each month the leasing installment plus VAT. However, if the company decides to choose a financial lease, it must remember that the lessor is required to charge VAT on the delivery of goods. The difference is that an entrepreneur who sells his fixed asset must pay VAT in full upfront.
Purpose of leaseback
For some lessors, the purpose for which you want to use the funds raised from a reverse lease can be quite important. In theory, you can spend the money for any corporate purpose, but in practice leasing companies have their preferences. Investment purposes are particularly welcome, but it is also possible to obtain a reverse lease in order to pay off other company obligations with it.
Another popular target is refinancing. An entrepreneur who wants to purchase machinery abroad with his own funds may want to immediately recover the costs incurred through a leaseback. This is a fairly common situation, and a good practice in such a case is to get in touch with the lessor even before purchasing the asset abroad and submit a lease application – all to make sure that your company has the conditions to obtain a lease.
However, if you are planning to use reverse leasing to improve your company’s liquidity, you must face the possibility of rejection from the leasing company. A better alternative in such a situation is to use online factoring, which is the sale of invoices with distant due dates.
Value of an asset in a leaseback
What value for a fixed asset should be taken when filling out an application? The answer is market value. However, this is not always possible to determine.
Example:
Ms. Elwira wants to import production lines from Germany and plans to refinance them with a leaseback. Before doing so, she submitted a lease application to one of the companies. She entered the market value as the value of the asset, even though she paid much less.
It is the leasing company’s duty to accept the market or near-market value, but in this case it is necessary to specify the degree of wear and tear of the production line, the year of production and the manufacturer’s brand – these parameters will allow the lessor to estimate whether it can undertake financing of the asset.
Example:
The lessor commissioned an appraisal of the asset and, based on the appraisal, adjusted the valuation previously prepared by Ms. Elvira. In this situation, the businesswoman may choose to increase her own contribution or reduce the transaction value of the asset to be in line with the lessor’s valuation.
When is it a good idea to use a leaseback?
Entrepreneurs are particularly fond of the option to lease back machines just after they have taken them out of the lease themselves. How does it work?
Example:
Mr. Norbert bought an industrial machine out of a lease. He paid PLN 25,000 for it at the time of the buyout, which corresponds to 10% of the initial value (PLN 250,000). However, in the time between the lease agreement and its termination, the value of this fixed asset has increased significantly, and now amounts to about PLN 400,000.
So if Mr. Norbert decides to lease back, he will invoice the lessor for PLN 400,000 – assuming, of course, that the object of the contract actually corresponds to market value.
Important!
Not for every asset will such a solution be beneficial. In the case of the application of a leaseback of a passenger car right after the lease buyback, the attractiveness of the solution significantly decreases due to numerous tax restrictions on the buyback of the vehicle.
This, of course, is not the only situation in which leaseback pays off. The general principle is simple: a company with high-value assets can gain a lot from leaseback. However, much depends on the specific arrangements between lessor and lessee.
