Operating Lease Off-Balance Sheet

How an Operating Lease Works

An operating lease is fundamentally a rental agreement for business equipment. The leasing company purchases the equipment and rents it to you for an agreed period, typically 1 to 5 years. You make regular lease payments and have full use of the equipment for your business operations. The lessor retains ownership throughout the lease term.

Because the lessor retains ownership and assumes the residual value risk, operating lease payments are typically lower than equivalent chattel mortgage or hire purchase repayments. The lessor factors in the expected resale value of the equipment at the end of the lease, reducing the amount you need to pay during the term.

At the end of the lease, you have flexibility. You can return the equipment and walk away with no further obligation. You can upgrade to newer, better equipment under a new lease. Or you can purchase the equipment at its fair market value, which the lessor determines based on the equipment's condition and current market prices.

Tax Advantages of Operating Leases

The tax treatment of operating leases is straightforward and often advantageous. Each lease payment is treated as a 100% deductible business operating expense. There is no need to separately calculate depreciation, interest deductions, or asset values — the entire payment reduces your taxable income.

For businesses in higher tax brackets, the simplicity and magnitude of this deduction can be significant. A business paying $2,000 per month on an operating lease deducts the full $24,000 annually against its taxable income. Compare this with a chattel mortgage where you need to calculate and claim depreciation and interest separately.

The GST treatment is also simple: GST is included in each lease payment and claimed as an input credit on each BAS return, spreading the cash flow impact evenly over the lease term.

Off-Balance Sheet Benefits

For businesses that report their financial position to stakeholders, lenders, or regulators, keeping equipment off the balance sheet through an operating lease can be strategically valuable. Because you do not own the equipment, it does not appear as an asset, and the future lease obligations do not appear as a liability under traditional accounting standards.

This improves financial ratios that stakeholders monitor, such as return on assets (higher because total assets are lower), debt-to-equity ratio (lower because lease obligations are not recorded as debt), and asset turnover (higher because revenue is measured against a smaller asset base).

It is worth noting that the AASB 16 Leases standard (effective for annual periods beginning on or after 1 January 2019) requires many leases to be recognised on the balance sheet for larger reporting entities. However, small and medium businesses that report under simplified frameworks may still benefit from off-balance sheet treatment. Consult your accountant for specific advice.

Industries and Equipment Suited to Operating Leases

Operating leases work best for equipment that depreciates rapidly, requires frequent upgrading, or where you prefer not to be committed to long-term ownership. Common applications include:

• IT and technology: Computers, servers, networking equipment, and software that become obsolete within 3 to 4 years
• Medical equipment: Imaging machines, diagnostic equipment, and dental chairs where technology advances rapidly
• Office fitout: Furniture, partitioning, and fixtures for leased office space where you may relocate
• Vehicle fleets: Company cars and light commercial vehicles where regular turnover is preferred
• Printing and copying: Commercial printers, copiers, and production equipment