Written byAn operating lease is a lease where you pay to use an asset for a set term and hand it back, with the financier keeping ownership and the resale risk.
Also known as: fully maintained operating lease, fleet lease
Key points
- The lessor carries the residual value risk; you simply return the asset when the term ends.
- Rentals are usually fully deductible for business use and attract GST that a registered business can claim on each payment.
- Terms are shorter than the asset's working life. A rental bundling servicing, tyres, registration and insurance is usually sold as a full service lease.
- Under AASB 16 the lease still goes on the lessee's balance sheet unless it is short-term or low-value.
How an operating lease works
The lessor buys the asset and rents it to you for a fixed term, typically one to five years, at a fixed monthly rental. You use the asset within agreed limits, such as a kilometre allowance on a vehicle, and return it in fair condition when the term ends. Because the lessor expects to sell or re-lease the asset afterwards, the rental only recovers part of the purchase price plus the lessor's return.
Excess kilometres, damage beyond fair wear and tear, and ending the lease early usually attract charges, so the fine print matters.
Tax and accounting treatment
For tax, the rentals are generally deductible to the extent the asset is used in the business, and a GST-registered business claims the GST on each rental. The lessor owns the asset and claims the depreciation. Cars above the ATO car limit have special rules, so check before relying on the deduction.
For accounting, AASB 16 removed the old off-balance-sheet treatment: most lessees now record a right-of-use asset and a lease liability for operating leases too, with exemptions only for leases of twelve months or less and low-value assets.
Who uses an operating lease
Businesses that replace assets on a cycle and do not want to own them: vehicle fleets, IT and office equipment, medical devices, and machinery that dates quickly. The appeal is predictable costs, no resale hassle and, with a maintained lease, one payment covering running costs.
If you want to own the asset at the end, a finance lease or chattel mortgage suits better. If you want ownership to arrive automatically with the last payment, that is a hire purchase.
Example
A courier company leases six vans on a three-year fully maintained operating lease. The monthly rental covers the vans, servicing, tyres, registration and insurance, and includes a kilometre allowance. The company claims the rentals and the GST on them, records the leases under AASB 16, and hands the vans back after three years, taking a fresh set on a new lease rather than dealing with resale.
Not to be confused with
- Finance lease
- a finance lease transfers most risks and rewards of ownership to you, including the residual; an operating lease leaves them with the lessor
- Rentals
- a short-term rental is day-to-day hire without a fixed term; an operating lease is a committed term with fixed rentals
Frequently asked questions
What is the difference between an operating lease and a finance lease?
Who carries the ownership risk. Under an operating lease the lessor keeps the residual risk, the term is shorter, and you return the asset at the end. Under a finance lease you carry the residual and usually keep the asset for most of its life, making an offer to buy it at the end.
Is an operating lease on the balance sheet?
For most businesses reporting under AASB 16, yes. The lessee records a right-of-use asset and a lease liability, with depreciation and interest recognised instead of a single rental expense. Only short-term leases of twelve months or less and low-value assets can stay off the balance sheet.
Are operating lease payments tax deductible?
Generally yes, to the extent the asset is used for business, and a GST-registered business can claim the GST on each rental. The lessor claims the depreciation because it owns the asset. Cars above the ATO car limit are treated differently, so check the rules for luxury car leases.
What happens at the end of an operating lease?
You return the asset to the lessor, who is responsible for selling or re-leasing it. You may be charged for excess kilometres or damage beyond fair wear and tear. Many businesses roll straight into a new lease on a replacement asset.
What is a fully maintained operating lease?
An operating lease where the rental also covers running costs such as servicing, tyres, registration and insurance, so the lessee pays one fixed amount each month. It is common for vehicle fleets and is sometimes called a full service lease.
Related terms
Broader term: Lease
Finance lease
A finance lease is a lease where the financier owns the asset and your business pays to use it for most of its life, taking on the risks of ownership.
Read definitionLease
A lease is a contract giving the lessee the right to use an asset owned by the lessor for a set term in return for payments.
Read definitionResidual value
Residual value is the amount a leased car or asset is expected to be worth when the lease ends, set at the start and used to calculate the rentals.
Read definitionFull service lease
A full service lease is a vehicle lease in which the lessor supplies the vehicle and bundles finance, maintenance, tyres, registration and fleet administration into one fixed monthly payment.
Read definitionLessor
A lessor is the party that grants a lease of property, goods or equipment to a lessee, keeping legal title while the lessee has possession and use.
Read definitionLessee
A lessee is the party that takes the right to use an asset, such as premises, a vehicle or equipment, from the lessor under a lease.
Read definitionGo deeper
Sources
This article is general information only and is not financial advice.