Finance Lease vs Operating Lease: Tax Treatment of Lease Payments

Introduction

Businesses often lease assets such as vehicles, machinery and equipment instead of buying them. The tax treatment of lease payments depends on the type of agreement: an operating lease or a finance lease. This article explains the difference in deduction treatment between the two and the effect of the accounting standard MFRS 16.

Operating lease: lease payments deducted as an expense

An operating lease is a short-term lease where the lessee uses the asset but does not bear most of the risks and rewards of ownership. For tax purposes:

• Periodic lease payments are deducted as a business expense under section 33(1) of the ACP 1967 if incurred wholly and exclusively for the production of gross income — subsection 33(1)(a).
• The deduction is prohibited under section 39 if the expense is capital or private in nature.

Finance lease: principal not deductible; interest deductible

A finance lease is an agreement where the lessee bears most of the risks and rewards of ownership of the asset. For tax purposes:

• Capital expenditure (principal) is not deductible.
• The interest portion may be deducted (subject to s.33/s.39).
• Tax treatment generally follows the legal form of the agreement (not merely the accounting treatment).

MFRS 16: accounting change does not change the tax treatment

MFRS 16 (accounting, from 1 January 2019) capitalises the right-of-use asset of a lease in the financial statements. Important:

• It does not change the tax treatment.
• Timing differences are reversed in the tax computation.

FAQ

Q. Can operating lease payments be deducted in full? A. Yes — periodic lease payments are deducted as a business expense under s.33(1) of the ACP 1967 if incurred wholly and exclusively for the production of gross income (s.33(1)(a)), and are not prohibited under s.39 (capital/private).

Q. What is the tax treatment of a finance lease? A. Capital expenditure (principal) is not deductible; the interest portion may be deducted (subject to s.33/s.39). Treatment generally follows the legal form of the agreement, not merely the accounting treatment.

Q. Does MFRS 16 change my tax? A. No. MFRS 16 capitalises a right-of-use asset in the financial statements from 1 January 2019, but it does not change the tax treatment; timing differences are reversed in the tax computation.