Client has a piece of equipment setup as a capital lease - capitalized for accounting purposes along with the long term debt liability.
Tax purposes - Not setup on schedule 8 - lease payments are deducted annually.
Midway through lease agreement, client pays out remaining lease balance of $80,000 on the equipment.
My thoughts are setup the $80,000 payment as addition to schedule 8; someone else informed me that the fully paid out amount is claimable as an expense.
I can’t find any support for either way - looking for advice/support on correct treatment.
At the time of the buyout there is no longer any question whether the client intended to return the equipment at the end of the lease, so I can’t imagine CRA (or court) allowing them to expense the $80,000. That’s a major reason for the CCA regime - to prevent the tax deduction of a capital asset (i.e. amortize the expense over the life of the asset). I’d agree with your “thoughts” - consider it a purchase as of that date for that payout amount.
I also agree including the $80,000 as an addition to CCA. I have done this many times and consider the “buyout” as the cost of the asset at that point in time.
To clarify, I would add as asset purchase then depreciate.
Capital lease is considered not a lease, it is a cost for the equipment starting the beginning. It should be captured as if it is an equipment being financed.
I think the current treatment by CRA is that they follow the documentation. If the document is a lease, it should be treated as a lease with the payments deductible in the year. Of course, that $80K buyout is not a deductible lease payment.
Late to the party but I came in with a question and saw this interesting one
You may have set this up as a capital lease, so (dr)assets and (cr)lease obligation, but there does not appear to be a follow though on the tax return with no Sch8 addition
As noted below, CRA says operating lease is the default and a capital lease treatment must be elected by both parties because tax consequences must be properly allocated and reported
Lessor==capital lease is a sale of equipment, operating lease is an agreement to rent out your owned property.
Lessee constructively buys asset under a capital lease, and only rents the asset under an operating lease
But you are not there yet.
What exactly does the documentation say?. Are you buying out the remaining lease obligation (A) where the assets is then transferred at nominal value, or are you buying what you were previously renting (B)
(A) leads you to write off the amount as lease payments
(B) says you bought an asset
I have a client who had a small trucking business and had a long haul truck under capital lease. In their FSs, they were treating it as a Financed Asset and depreciation was recorded. For tax purposes, they were adding back the depreciation to the net income and deducting lease payments only. This all sounds correct to me as per your discussions above. My question now is that the client has exercised the BPO at the end of term and bought the truck from the lessor. Later the truck was sold for 150k and the buy out amount at the end of term was 20k so now is 130k a capital gain or just a normal gain and fully taxable?? Please if someone can share their views?
Not sure if I’m correct but I was thinking it as a fully taxable as a Recapture. Because the lease payments that were claimed in all those years could be assumed as CCA and the remaining buyout price of 20k after those lease payments as the UCC balance. So the asset is sold for more than what was left for claiming in the UCC balance resulting in a recapture.
I have this info from a VTN seminar in 2021. See attached related pages. If you look at pg221 lines 21 to 29.
"for purposes of computing recapture and capital gains on future sale of the asset, the original cost of the asset is deemed to be the lesser of: the buyout price plus all lease payments previously deducted; and the fair market value of the asset at the acquisition date. The difference between the cost as determined above and the buyout price is deemed to be CCA previously claimed on the asset."
Bases on this the recapture will be higher thus being full taxable.
Lots of overthinking going on here… let me break it down for you all as easily as I can …
No schedule 8 = No UCC, no CCA… although this should have been considered if the lease was capitalized …
Recapture only applicable assuming CCA was taken in PY’s … You should have kept a historical record of schedule 8 additions and the recapture would be calculated on this basis up to the amount of original capitalization (you may need to override).
The accounting gain/loss is recorded as such:
Dr. Cash Received
Dr. Amortization of Equipment
Dr. Lease liability - Equipment
Cr. Equipment
Dr/Cr. Gain or loss on equipment
There’s no reason to consider FMV outside of these entries, as this is considered in the cash component of the above. The only time you would consider a FMV adjustment is when you are subjected to ASPE or IFRS standards.
Accordingly, the lease principle should have amortized the liability, and the interest component should have been expensed to the I/S.
On page 221 of the VTN document that @grangers2016 attached it seems the CRA have a bit of a different take on this;
However, for purposes of computing recapture and capital gains on future sale of the asset, the original cost of the asset is deemed to be the lesser of:
1 - the buyout price plus all lease payments previously deducted
and
2 - the fair market value of the asset at the acquisition date.
The difference between the cost as determined above and the buyout price is deemed to be CCA previously claimed on the asset.
It’s worth also mentioning that to claim CCA on a capital lease, form T2145 should have been elected initially (but I see this more in practice when working with IFRS standards). I’m surprised no one mentioned the lessor of UCC. VTN is credible, and we do use them for pro-D with my firm. I believe they’re referring to CCA from a notional standpoint, as you cannot have a recapture if no CCA was taken to begin with. I’m not sure if this was the case here or not, but it sounds like that would be your plug to P/L otherwise