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Tax Management with reference to –Lease or Buy Decisions

 

LEASE OR BUY DECISIONS

Assets may purchased or taken on lease. Apart from tax angle other factors also are important in taking lease or buy decisions like rate of change in technology.

Advantages when Assets are taken on Lease : Lease Rental can be claimed as deduction as revenue expenditure. However Depreciation cannot be claimed since assets are not owned by the assessee.

Advantage when Assets are Purchased :         Depreciation on specified assets can be claimed as deduction u/s 32. the Assets may be purchased outrightly or may be taken on loan. Where the asset is taken on loan interest amount can either be claimed as revenue expenditure or can be capitalized. But where interest is paid after the asset is first put us use, the deduction on account of interest shall be claimed as revenue expenditure, i.e. such interest cannot be capitalized.

Note :

>> Since the lease rentals and loan are repayable in instilments, then the cash outflow  for each separate year should be converted into present value of today’s cost, i.e. Cash Inflow.

HOW TO SOLVE QUESTIONS

Where the Asset is Purchased on Loan :

  1. Compute Repayment of Loan spread over a number of years.

  2. Compute Interest on Loan spread over a number of years.

  3. Compute each Outflow ( Interest + repayment of Loan) spread over a number of years.

  4. Compute Depreciation on Assets spread over a number of years.

  5. Compute Tax saved on deduction claimed ( Interest + depreciation) spread over a number of years.

  6. Compute adjusted cash outflow which is ( 3 – 5 )

  7. Compute present value of adjusted cash outflow.

Where the Asset is Leased :

  1. Compute the time processing fees in zero year.

  2. Computer Lease Rental spread over a number of years.

  3. Compute Cash Outflow (processing fees + lease rental) spread over a number of years.

  4. Compute Tax saved on deduction claimed ( processing fees + lease rental) spread over a number of years.

  5. Compute adjusted cash Outflow which is ( 3 – 4 )

  6. Compute present value of adjusted cash outflow.

What is the Present Value (PV Value) :

It is the discontinue value, its opposite is future value of cash investment which you make today. In simple terms what is the value of cash in ‘Zero year’ when there is cash outflow in 5th year or for that matter nth year. To discount the cash outflow occurring in 5th year, there is table given which is known as annuity table. This is shown below by way of illustration.

E.g.  Computer Present Value of cash outflow from the following information :

Cash Outflow                                                    1st Year                        2nd Year           3rd. Year

                                                                       Rs.80,000                     Rs. 40,000         Rs. 50,000

PV factor at 10% of internal return                       0.909                           0.826                 0.751

Solutions :       

Discounted Value in Zero Year                        Rs. 72,720                     Rs. 33,040         Rs. 37,550

The Value of  Rs. 72,720   Rs. 33,040  Rs. 37,550 represents discounted value of Zero Year.

 
 
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