SIDEBAR: Buy or Lease?

Kieran Lane, partner in charge of tax for the Information, Communication and Entertainment Group for KPMG, has no doubt some companies have let millions of dollars slip through their fingers by allowing a mismatch between their tax result and their cash outlays.

"It is important to consider, and if you get it wrong, then you need to understand that you will have a mismatch between your tax result and your cash outlays," Lane says. "CIOs should be connecting with their in-house treasury guys because they'll be able to do the numbers probably better than the CIOs."

Lane presents the following guide concerning the tax and associated commercial benefits of leasing software over purchasing software outright.

Benefits of Leasing Software

Cash flow stability. New leased software will allow an entity to preserve its existing cash flow and to be able to respond to new business opportunities. Funds that could be used to buy inventory, advertise and hire personnel may be better spent doing just that rather than spent purchasing software that is worth less and less as time goes by.

Software obsolescence. Since technological changes occur extremely quickly, by leasing, an entity lessens the risk of ending up with obsolete software. This is because the agreements allow an entity to build upgrades and add-ons into the lease.

Flexible payment terms. Software leases may be structured to suit the needs of the lessee by giving the lessee the opportunity to make the most of such lease structuring variables as number and amount of advance payments, purchase option and so on.

Avoid ownership risk. Leasing places all of the risk of ownership with the lessor, allowing the lessee to upgrade or add new equipment as the need arises.

Disadvantages of Leasing Software

Early termination. The terms for early termination of the software leases can be unfavourable for the lessee.

Leasing Alternatives

1. Hire Purchase

• If considered to be a contract for sale, the hirer is the owner and therefore is entitled to deduct depreciation of the software.

• The hirer can also deduct the interest charges associated with the purchase of the software; however, the hirer cannot deduct the principle amount.

• Depreciation and interest costs are positively aligned with the associated tax deductions.

• There is a potential mismatch between accounting and tax depreciation.

2. Lease

• The lessor is generally the owner, therefore the lessee will not be entitled to claim depreciation; however, the lessee is entitled to claim the lease payments in full.

• Lease payment costs are positively aligned with the associated tax deduction.

• There is no potential mismatch between accounting and tax depreciation.

Depreciation: Acquiring Vs Developing In-house Software

• You can only use the prime cost deprecation method.

• The effective life is two-and-a-half years; therefore the depreciation rate is 40 percent.

• You are entitled to a deduction of the full cost of the software, where after buying it, you decide that you will never use it.

• There is a potential mismatch between accounting and tax depreciation.

• The cost of software and associated deduction are not perfectly aligned (that is, deduction over two-and-a-half years).

• Repairs and upgrades are the responsibility of the owner; if repairs are required, issues arise as to whether they are revenue or capital in nature.