Getting the right equipment is essential for your medical or dental practice. Equipment finance options include buying, leasing and entering into a hire-purchase arrangement.
Each option has its own advantages and disadvantages and there are differences in how they are treated for tax purposes.
When you purchase equipment, you gain legal ownership of it.
You are free to deal with it however you like, including leasing it out to another party or selling it when you no longer require it.
As the owner, you are assuming the risks of ownership. You have to ensure the equipment complies with safety regulations, undertake regular maintenance and organise your own insurance.
You are able to claim depreciation on the cost of equipment as a tax deduction.
If you satisfy certain requirements, you may be entitled to immediate asset write off. The eligibility depends on your annual turnover and on the date of acquisition and first use.
Paying for medical equipment outright may not be the best option as it ties up your working capital. The better alternative is to finance the purchase using a chattel mortgage. A chattel mortgage is an equipment loan where the equipment is used as a security against the loan.
The main benefit of using finance to purchase your equipment is cash flow advantage.
Using a loan does not affect your ability to claim immediate asset write off for the cost of equipment, which enables you to get full tax advantage without having to make cash outlay for the full cost.
You will make periodic repayments to your finance provider consisting of principal component (basically, the cost of equipment) and interest component.
The interest component will be tax deductible in the period in which the payments are made. Interest component payable on the loan is not subject to GST as loan is a financial supply.
You cannot claim tax deduction for the principal component of the repayments. These payments representing costs of equipment are claimed by way of depreciation.
If interest component is not stated separately in each period by your finance provider, ask your accountant to prepare loan amortisation schedule to work out how much exactly you can claim on your repayment in each relevant period.
If you cannot get advantage of immediate deduction for the cost of equipment, or if you do not want to commit to buying it, leasing can be a better equipment finance option.
Leasing gives you more flexibility compared to purchasing as you do not have to deal with the risks of ownership. The finance provider purchases the equipment from your preferred supplier and leases it back to you for a fixed term, typically being 12, 24, 36, 48 or 60 months (depending on a provider).
Leasing gives you the ability to upgrade your equipment if it becomes outdated. However, breaking lease early can involve substantial penalties. It is important to ensure you understand the terms of your lease contract specifying rights and responsibilities of each party.
For tax purposes, lease payments are 100% tax deductible in the period when they are made. As you are not the owner of the asset, you are not entitled to claim depreciation deduction on the asset cost (note that the tax treatment differs from treatment set out by Accounting Standards). Lease payments are subject to GST which you can claim back.
At the end of the lease, you may have an option to purchase the equipment by paying a residual amount. A lease is considered to be a genuine lease if the residual value reflects the market value of the asset at the end of the lease period.
However, establishing market value can be difficult in practice. In IT28, the ATO provides minimum residual values expressed as percentages of cost based on the lease term and prime cost depreciation rate of the asset.
Hire-purchase is another form of equipment finance similar to a lease.
As in a lease, the finance provider buys the equipment and hires it to you for a specified period of time. At the end of the period, you have an option to buy the equipment by making a residual payment (balloon amount or the last instalment). Balloon amounts in hire-purchase agreements (unlike residuals in a lease) can be negotiated with providers. Not all hire-purchase agreements have a balloon.
From legal point of view, the financier remains the owner of the equipment and the title does not pass to you until you make the residual payment.
However, for income tax purposes, the arrangement is treated as a sale and loan. You are taken to have acquired the equipment from your finance provider when the hire-purchase agreement is signed. The finance provider is taken to have provided you the loan for the purchase price.
Just like a chattel mortgage, this notional loan is subject to interest charge, which is tax deductible. As a notional buyer, you can also claim deduction for depreciation on the cost of equipment.
For hire purchase agreements made after 1 July 2012, you can claim GST credit on purchase up-front, even if you report GST on cash basis.
Please note that for hire-purchase agreements made after 1 July 2012, all components of the supply are subject to GST. Unlike loan interest, interest charge on hire purchase is also taxable irrespective of whether or not the amount is separately disclosed.
What equipment finance option is right for you?
You need to consider your specific circumstances to determine what equipment finance option is right for your medical or dental practice. We strongly recommend consulting appropriately qualified professionals before making your decision.
At Prism Accounting, we can assist you in making the right equipment finance choice by advising you on the tax consequences as well as preparing cash flow and income tax projections for each option.
Do you need to speak to a medical accounting specialist? Send us an enquiry or call our office for a confidential discussion of your matter.