Leasingfrom the large first-year allowance. This was particularly true where recession re-
stricted profitability.
With leasing, the right to claim capital allowance passed to the ‘lender’. If the profits
from leasing and other activities were such as to put the ‘lender’ in a position to take
full advantage of them, some of this advantage could be passed on to the ‘borrower’
in lower lease payments. Thus the ‘borrower’ could give up some of the advantage of
the first-year allowance in exchange for a lower lease charge.Evidence on leasing
The advent in the mid 1980s of lower corporation tax rates and the abolition of the
100 per cent first-year tax capital allowance greatly reduced the benefit of finance
leasing. This, taken together with the requirement for the ‘borrower’ business to dis-
close in its annual accounts the extent of its indulgence in this source of finance,
seemed likely to reduce the level of use of finance leasing.
In fact, far from decreasing in popularity since the accounting and tax changes of
the mid 1980s, finance leasing has expanded massively in popularity since the late
1980s. The reasons for this fact are not obvious. Drury and Braund (1990) conducted a
survey of UK businesses of various sizes on the reasons why they frequently prefer to
acquire assets on finance leases rather than buying them. There were two principal
reasons given for the popularity of leasing. The first was that the interest rate implied
in leasing contracts was lower than the rate that the businesses would have to pay to
raise finance to buy the assets themselves. The other main reason given was that they
believed it still to be more tax efficient to lease rather than to buy, despite the changes
in the tax treatment of non-current assets. British Airways plc, according to its 2007
annual report, leases a significant part (29 per cent of balance sheet value) of its fleet
of aircraft.
Although in some cases one or both of the principal reasons given in the Drury and
Braund survey could be valid, for the majority of businesses this seems unlikely to be
so. Drury and Braund discovered one factor that could cast some light on the subject.
This was an alarmingly high incidence of mishandling of the analysis of the decision
whether to lease, on the one hand, or to borrow and purchase, on the other. Even
among larger, and presumably more financially sophisticated, businesses, about 30
per cent were taking an incorrect approach to the analysis such as to bias the results
in favour of a decision to lease.
Although it would be unreasonable to conclude that the continued popularity of
finance leasing is based on wholesale mishandling of the decision data, it remains far
from clear as to why leasing is so popular.To lease or not to lease – a financing decision
When a business is considering the acquisition of an asset, it should estimate the cash
flows that are expected to arise from its ownership. These should then be discounted
at a rate that reflects the level of risk associated with those cash flows. If the NPV is
positive the asset should be acquired; if negative it should not, at least from a financial
viewpoint.
Whether the asset should be financed by a finance lease or by some other means
is a completely separate decision. The first is an investment decision, the second a
financing one.