Is it better to lease or buy a car for a business in Canada?

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If you are a business owner or an employee who needs a car for work, you should know whether it’s more tax efficient to lease or buy a car for a business in Canada. If your company provides you with a car check out these tax implication for that situation. There are several steps involved in answering the question, “Is it better to lease or buy a car for a business in Canada?”

Buying a Car – Tax Savings

Step 1: Calculate the cost of the car including fees and HST

I phoned a local Toyota dealership in Toronto, Ontario, Canada and I asked, “How much does it cost to buy a Toyota Camry LE?” The total cost including Freight, PDI, other fees, and HST is $34,910.

Step 2: Calculate the Maximum Amount for Capital Cost Allowance

The second step when deciding to lease or buy a car for a business in Canada is to calculate the maximum amount of the cost of the car that you can depreciate for tax purposes. Depreciation (also known as capital cost allowance or CCA) for cars is 30% per year, and its tax deductible. The maximum cost of a car that is eligible for depreciation is $30,000. Since the pre-tax cost of the Toyota of $30,894 exceeds the $30,000 limit, only $30,000 will be eligible for depreciation.

Step 3: Calculate Capital Cost Allowance Deductions

In step 3, the total capital cost allowance (CCA) deductions are calculated:

• In year one, the CCA is equal to $30,000 x 30 percent x ½ = $4,500. The 50% reduction (also know as the ½ year rule) only applies in the year of acquisition of the car.
• In year two, the CCA is equal to $30,000 minus $4,500 (the depreciation claimed in the previous year) x 30% = $7,650.
• In year three, the CCA is equal to $30,000 minus $12,150 (the depreciation claimed in the two previous years) x 30% = $5,355.
• In year four, the CCA is equal to $3,749.

The total CCA over four years is $21,254. I’ve assumed that you are going to own the Toyota Camry LE for 4 years, but the analysis can easily be adjusted if you plan to own your vehicle for a longer period of time.

Step 4: Calculate the Tax Saving

In step 4 of the buy analysis, calculate the tax savings from deducting the CCA (from step 3) on your personal tax return. I made the following assumptions:

• Your personal tax rate is 40%.
• The residual value of the car is $11,898 (confirmed by Toyota Dealership). This means that after four years the car is worth $11,898.
• You use the car 70 % of the time for business purposes.
• The total interest cost over the 4 years to finance the purchase is $1,371 or 1.9% (confirmed by dealer).

When deciding to lease or buy a car for a business in Canada the tax savings related to buying can be calculated as follows:

$21,254 (Total CCA deductions)                 

$1,371 (Interest expense 4 years)

$22,625

x 70% (Multiplied by business use)

$15,838

x 40% (Tax rate of 40%)

$6,335 Tax Savings

The total tax savings from buying a car is $6,335.

Step 5: Calculate the After-Tax Cost of the Car

Step 5 while contemplating a decision to lease or buy a car for a business in Canada is to calculate the after-tax cost of the car over the period of ownership.

$34,910 (Cost of car (from step 1))

$1,371 (Interest)

$36,281

($11,898) (Less: residual value in year 4)

($6,355) (Less: tax savings (step 4))

$18,048 or $4,512 per year (After Tax Cost of Car)

In summary, the after tax cost to buy the Toyota Camry LE, is $18,048 or $4,512 per year. This concludes the buy analysis in answering the question, “Is it better to lease or buy a car for a business in Canada.”

Leasing a Car – Tax Savings

The next part while completing leasing or buying a car for a business in Canada involves calculating the after-tax cost of the lease.

Step 1: Calculate Cost of Lease

In Step 1, you must calculate the cost of a lease over the lease term. When I phoned the Toyota dealership, I was informed that the monthly lease payment including taxes is $516, and the interest rate implicit in the lease is 2.9%. The maximum deduction permitted by the Canada Revenue Agency (CRA) for lease payments is $800 per month plus taxes. Since the lease amount of $516 per month for the Toyota is less than the maximum amount of $800, plus taxes, the full amount of the Toyota lease is tax deductible. The total cost of the Toyota lease over 4 years is $24,768 ($516 x 48 payments).

Step 2: Determine Tax Savings from Lease

Step 2 is to calculate the tax savings from deducting the lease payments on your personal tax return.

$24,768 (Lease cost over 4 years)

x 70% (Business Use %)

$17,338

x 40% (Your personal tax rate)

$6,935 tax savings from lease

The tax savings from deducting the lease payments is $6,935.

Step 3: Calculate After Tax Cost of Lease

Step 3 when deciding to lease or buy a car for a business in Canada is to calculate the after-tax cost of the lease.

$24,768 (Lease cost over 4 years)

$6,935 (Less: tax savings)

$17,833 after tax cost of lease

The after tax cost of the lease over 4 years is $17,833, or $4,458 per year.

Step 4: Compare Cost of Buying Car to Cost of Leasing Car

The final step is to compare the after-tax cost per year from buying a car to the after-tax cost per year from leasing a car.

Leasing is Cheaper!

The after-tax cost per year for buying a Toyota Camry LE is $4,512. This is greater than the after-tax cost of leasing for $4,458 per year. In this example it makes more sense to lease the car than buy. Each situation is different, so it’s important to complete the analysis each time when comparing whether to lease or buy a car for a business in Canada.

Non-Tax Costs – Leasing

The other non-tax costs that you should take into consideration when leasing a car for work or for business purposes are:

• Once you return the leased car after the lease is finished, the car dealer will require that you perform certain repairs so that car is in a salable condition.
• Car dealers often limit the number of kilometers that you can drive on a lease. Extra kilometers over the limit are charged to you.
• Pride of ownership is greater when you buy your car and you will probably take better care a purchased vehicle.
• Cash-flow is another factor to consider. The monthly payments are almost always lower on a lease than they are when financing a car purchase  or an outright purchase.
• Finally, the interest rate implicit in the lease and the interest rate charged on a car purchase loan are very important to take into account.

Stand By Charges

When deciding to lease or buy a car for a business in Canada you must account for standby charges. A standby charge is a benefit the employee receives when an automobile is provided by their employer and is available for personal and business use. The cost is calculated based on:

• Original purchase price or monthly lease cost on the car (Including all taxes)
• Number of months the car is made available to employee for personal use
• Number of KM for both business and personal use
• Any reimbursements by employee for availability of vehicle

To calculate the standby charge for your business we will use the examples we have discussed above and add in a few more details.

• To buy a Toyota Camry LE the cost is $34,910
• To lease a Toyota Camry LE the monthly price would is $516.
• The car will be made available to the employee for 1 year (12 months)
• The total kilometers driven in the year was 30,000, of which 10,000 kilometeres was for personal use.

Stand by Charge for Buying

The formula for calculating the standby charge when the automobile is owned by the employer is: 2% x cost of automobile x #months available to employee in the year

2% x $34,910 x 12 = $8,378

Stand by Charge for Leasing

The formula for calculating standby charge for a leased automobile by the employer is: 2/3 x monthly lease cost (excluding insurance) x # months available to employee in the year

2/3 x $516 x 12 = $4,128

In this case, it benefits the employee if the car was leased, because the standby charge is smaller for leased vehicle than a purchased vehicle. The standby charge is a taxable benefit that will be reported on your employment income slip (T4) and will increase your taxable income.

Standby Charge Reduction

You may be able to reduce your standby charge even further if the following conditions are met:

• 50% of the kilometers driven by the employee are attributed to business use
• Less than 20,004 km/year are driven for personal use

Since business use is more than 50% of our total kilometers driven (20,000/30,000) we now have a reduction to our standby charge calculations. The new standby charge for purchasing a car would be:

$8,378 x (10,000/20,004) = $4,188

And to Lease:

$4,128 x (10,000/20,004) = $2,064

By limiting an employee’s personal use kilometers to less than 50% of the total kilometers driven in the year, you can save yourself half of the taxable benefit from the standby charges.

Operating Cost Benefit

When you are provided with a company leased or company owned vehicle, an operating cost benefit will be reported on your employment income slip (T4). This is on top of the standby charge discussed above.

Operating costs include:

• Gas and Oil changes
• Maintenance charges and repair expenses
• License and Insurance

There are two methods of calculating your operating cost benefit. The first is multiplying the personal use kilometers driven by the standard rate given by the CRA of $0.27/km.

The second method is only available if at least 50% of kilometers driven by you were attributed to business use. To calculate the operating benefit under this method, you must multiply your standby charge amount by 50%. Which ever method results in a lower operating cost benefit can be added to income.

If we use the same details as the standby example, the operating cost benefit for buying or leasing a car would be as follows:

Buying a Car – Operating Cost Benefit

Lesser of:

1) 10,000 km x $0.27 = $2,700 Since 66.67% (20,000/30,000) of the kilometers driven were connected to business uses, we can calculate the operating cost benefit using our alternative method. 2) $4,188 x 50% = $2,094

Since (2) is lower than (1), the alternative method of calculating the operating cost benefit results in a lower taxable benefit to the employee. Therefore the total taxable benefit to the employee would be $4,188 (standby charge) + $2,094 (operating cost benefit) = $6,282.

Leasing a Car – Operating Cost Benefit

Lesser of:

1) 10,000 km x 0.27 = $2,700

2) $2,064 x 50% = $1,032 [Alternative Method]

Since (2) is lesser than (1), the alternative method results in a lower operating cost benefit. Therefore the total taxable benefit to the employee would be $2,064 (standby charge) + $1,032 (operating cost benefit) = $3,096.

Tax Tip: If your employer is giving you a car for business use and your personal kilometers are less than 50%, make sure they reduce your operating cost benefit.

Tax Tip: The CRA has an online calculator that you can use to calculate the operating cost benefit and standby charge.

Why Not to Place a Down Payment on a Lease

When leasing a car you may want to put a big down payment so your monthly payments are reduced. However this is not a good tax move as you may be chipping away at your lease deduction. As mentioned above the CRA permits a maximum monthly deduction of $800 for leased vehicles. We have established that the monthly lease payment of a Toyota Camry LE is $516 a month. If you were to put a $5,000 down payment on the car the monthly payment would decrease to 436.67 (Financial calculator).

Although you have decreased your monthly payment you will not be able to deduct the down payment portion. After the monthly payment is subtracted from the 800 deductible limit you will only have $363.33 (800 – 436.67) left to deduct. This portion can only be claimed in the first year you leased the car.

For a $5,000 down payment the maximum portion you will be able to deduct (if you leased the car in January) is $4360 (363.33 x12). That means that $640 (5,000 – 4360) of the down-payment is non deductible.

If you must make a down payment on a lease make sure that you have enough excess deduction to cover the down payment in the first year of payment.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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