Tax aspects of leasing industry

Extracted from The Star, 27^th Sept 1999

The leasing industry is comparatively new in Malaysia but has made remarkable strides in recent years. The first leasing company is said to have commenced operation in 1973.

Based on data obtained from the Equipment Leasing Association of Malaysia (ELAM), the number of company grew from nine in 1979 to about 149 in 1984. There were, however no rules to govern this industry since the inception of the Income Tax Leasing Regulations 1986 which came into force on April 8 that year.

The principal objective of the Income Tax Leasing Rules is to regulate the business activities in the leasing industry. Although precise figures are not available, it is estimated that funding provided by non-bank financial institutions was around RM21bil in 1997. It is further estimated that one third or RM7bil of this total was provided by leasing or factoring companies.

Definition

A lease can be defined as a contract between the owner of an asset (referred to as a lessor) and the hirer (lessee) for the letting of (leasing) an asset. The contract would allow the lessee to use the asset for a specified period of time.

The lessee pays a predetermined monthly rent to the lessor for possession and use of the asset. The lessor, throughout the lease period, would retain the legal ownership of the leased asset.

A lease term means the period for which the lessee has contracted for use of an asset. In situations where a lease arrangement has been terminated earlier than its agreed expiry date, the lease term is the actual period of the lease.

A special purpose asset means a leased asset where no other use can use the same asset without making alterations or adjustments to the existing structure or land. For income tax purposes, a special purpose asset which is an integral part of the building shall be deemed to be a movable property.

Mode of purchase

A prospective user of an asset has three options: to purchase an asset outright, to by it on hire-purchase, or to lease it. The mode of purchase of the asset would depend on several factors such as availability of cash, nature and cost of asset, duration of use and, of course, tax benefits.

Tax Benefits

·         Outright purchase.

A user who purchases an asset outright will not be allowed a direct deduction for tax purposes. Instead, he will be allowed a capital allowance computed on a straight lien basis.

The initial allowance is 20% of cost incurred in the year while the annual allowance vary between 10% and 40%, depending on the nature of the asset.

The rate of allowance for motor vehicles is 20% while computers used for the business are given an increased annual rate of 40%.

·         Hire-purchase

A user who acquires an asset on hire-purchase terms is deemed to be the owner of the asset (Paragraph 46 Schedule 6 ITA). The user will, therefore, be given capital allowances on the capital potion of the cost.

The income tax provisions, however, limits the qualifying expenditure, in respect of motor vehicles (other than commercial vehicles) to RM50,000.

·         Lease

When a user leases and asset, the rental payable each year will be an allowable deduction from the gross income over the period of the lease.

As for car leasing, any sums paid by way of rental in excess of RM50,000 is disallowed (Sec 39(1)(k) ITA). This restriction does not apply to commercial vehicles

Special treatment

The Director-General of Inland Revenue (DGIR) is given powers to make rules regarding the tax treatment of leased assets.

·         Separate business source

The leasing rules provide that leasing income shall be deemed to arise from a separate business source, distinct from income from other business activities.

It follows that capital allowances in relation to the leasing business cannot be used to set-off from other business sources.

Moreover, the gross income of a lessor will be deemed to accrue evenly over the period of the lease term.

The normal deduction rules laid down in the ITA will govern the allowability of expenditure in respect of the lessors trade. In general, the expenses are permitted if they are wholly and exclusively incurred in the production of income.

·         Terminal payments

Where any terminal payments are made by the lessee to the lessor as compensation for terminating the lease, such payments would be deemed taxable income in the hands of the lessor.

Types of lease

There are several types of lease and they include: operating lease, finance lease, sale and lease back and leveraged lease.

An important distinguishing feature between an operating lease and a financial lease relates to the lessors activity. If the lessor lends money to make a profit in the form of interest, the lease is a finance lease. If the lessor conveys to the lessee the right to use the asset, the lease is an operating lease.

When there are cash-flow problems, a company or a firm can sell an asset and subsequently lease it back. Such a lease can either be an operating or finance lease, depending on whether the lessor retains the risks and benefits incidental to the ownership of the asset.

Leveraged lease involves large amounts of money and normally has a long gestation period. Finally, a leveraged lease is a finance lease the involves third parties who provide the required funding to purchase the asset that is to be leased to the lessee.

Conclusion

Leasing offers to a lessor several advantages over ownership of an asset. Under existing tax laws, lease rental incurred are considered operating expenses and hence deductible from taxable income.

Moreover, the lessor has the leased asset as a form of security and should there be financial problems, the lessor can legally repossess the asset. The lessee, too, benefits in obtaining full deductions (with exceptions) of lease rental if the leased asset is used exclusively for the production of income.

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