What is a finance lease?

A finance lease is a long-term rental arrangement where the lender owns the asset throughout the term, you make fixed lease payments, and a residual value is owing at the end. It sits alongside chattel mortgage and hire purchase as one of the three main asset finance structures in Australia. This article covers how finance lease works, the tax treatment, and when it suits. For a head-to-head comparison, see chattel mortgage vs hire purchase vs finance lease.

How a finance lease works

The lender buys the asset and leases it to you for an agreed term, typically 2 to 5 years. You make fixed lease payments (often monthly) that cover the lender cost of capital plus a contribution towards the asset value. The lender retains legal ownership throughout the term.

At the end of the term, a residual value (also called a balloon or guaranteed future value) is owing. You have three options at that point: pay the residual and acquire the asset, refinance the residual into a new facility, or hand the asset back to the lender. The residual is typically 20 to 40 per cent of the original asset value, set at the start of the lease.

Throughout the term you have full operational use of the asset - it sits in your workshop or fleet exactly as if you owned it. The lender ownership is mostly a legal and accounting distinction rather than an operational one.

Finance lease vs operating lease

Finance lease and operating lease are often confused because both involve renting an asset. The difference is who carries the residual value risk.

Finance lease: you carry the residual value risk. If the asset is worth less than the residual at end-of-term, you still owe the full residual. If it is worth more, the surplus is yours (after paying out the residual).

Operating lease: the lender carries the residual value risk. You hand the asset back at end-of-term with no further obligation. The lender bears the resale risk. Lease payments are typically higher than finance lease for the same asset because the lender is pricing in the residual exposure.

For most business assets where you expect to use the asset throughout its full useful life, finance lease is the cheaper structure. For situations where you want to refresh equipment regularly without residual risk (typical in tech and fleet vehicles), operating lease can suit better.

Tax treatment

Lease payments under a finance lease are fully deductible as a business expense (subject to specific rules for motor vehicles and certain other categories). GST on each lease payment is claimable in the BAS in which it is paid.

For accounting under newer Australian standards (AASB 16), most leases over 12 months appear on the balance sheet as a "right of use" asset plus a corresponding lease liability. This is different from pre-2019 treatment where finance leases were on-balance-sheet but operating leases were not. The practical effect for most SMEs is administrative rather than financial.

Depreciation under finance lease is generally not claimed by the lessee - the lender depreciates the asset because they own it. This is the main structural difference from chattel mortgage, where the borrower owns and depreciates.

When finance lease fits

Finance lease suits situations where:

You want predictable, fixed-cost asset financing across the lease term, without surprises at settlement (the up-front GST claim under chattel mortgage can confuse cash flow forecasting for some businesses).

You may or may not want to own the asset at end-of-term, and want the flexibility to decide later.

Your tax position favours fully deductible lease payments over the depreciation + interest split of a chattel mortgage. Common in some trust structures and certain partnership arrangements.

You operate a fleet or rolling stock that gets refreshed on a regular cycle, and the residual exit gives you a clean handover point.

When finance lease is not the right answer

For most profitable, GST-registered businesses buying standard assets, chattel mortgage is structurally cheaper because of the up-front GST claim plus depreciation. Finance lease becomes the right answer for specific tax positions or when the optionality at end-of-term genuinely matters.

See what is a chattel mortgage for the alternative most ABN holders end up choosing.

Common questions

What happens if I want to keep the asset at end-of-term? Pay out the residual value to the lender. You then own the asset outright.

What if the asset is worth less than the residual? You still owe the full residual to the lender. If you sell the asset for less, you fund the shortfall from cash. This is the residual value risk you are taking on under a finance lease.

Can I exit early? Usually yes, with a break fee. The exact cost depends on the lender and how far through the lease you are.

Who insures the asset? You do. The lender requires comprehensive insurance with their interest noted on the policy.

Can I modify the asset during the lease? Typically only with lender consent, since they own the asset. For permanent modifications you usually need to pay out the residual and own the asset first.

Where to from here

We arrange finance lease, chattel mortgage and hire purchase across our whole asset-finance lender panel. No fees to clients; the lender pays us when finance settles. A 20-minute brief with your accountant if relevant is enough to work out the right structure. Book one through our contact page.