Finance lease: equipment leasing without ownership

A finance lease is a rental agreement in which the lessor (the lender) owns the asset and your business pays rentals that cover most or all of its cost, plus a finance charge, over an agreed primary period. You choose the asset and supplier, the lessor buys it, and you take delivery and use it as your own. Unlike a short-term rental, the risks and rewards of the asset sit largely with you: you insure it, maintain it and bear any fall in its value, while the lessor's role is essentially that of a funder. Legal ownership never passes to your business.

The primary period is the main term of the lease, during which your rentals pay off the lessor's investment in the asset. It is usually set to match the asset's useful life, typically two to five years, and rentals are commonly monthly or quarterly. Rentals can be fixed for the whole term, and many lessors can profile them: an upfront payment of several rentals in advance, seasonal schedules, or lower rentals in the early months while a new machine beds in. By the end of the primary period the lessor has normally recovered the full cost plus its return, which is why this type of lease is often described as full payout.

When the primary period ends, most finance leases let you keep using the asset for a secondary period at a very low rental, often called a peppercorn rent. The peppercorn is a nominal sum, typically paid annually, that keeps the lease alive while the asset still has useful life left. The secondary period can usually run on year by year, or for a fixed number of years set out in the agreement. It suits assets that last well beyond the primary term, such as machine tools or production lines.

With a finance lease, VAT is charged on each rental rather than on the full asset price at the start. That is a key difference from hire purchase, where VAT on the asset is normally payable upfront. A VAT-registered business can usually reclaim the VAT on rentals through its VAT returns in the normal way, so the cash flow benefit comes from not having to find a large VAT sum on day one. Special rules apply to cars and to businesses that are partly exempt, so ask your accountant how the rules apply to you.

Because the lessor owns the asset, the lessor normally claims the capital allowances on it, and your business usually deducts the lease rentals as a business expense instead. That can suit businesses that cannot make full use of capital allowances themselves. Some longer leases are treated differently for tax, and the timing of deductions follows your accounting treatment, so this is an area for professional advice. Our guide to asset finance and capital allowances explains how ownership affects tax relief.

The accounting treatment depends on the framework you report under. Companies using IFRS 16 bring most leases onto the balance sheet as a right-of-use asset and a lease liability. UK companies reporting under FRS 102 have historically recognised finance leases on the balance sheet and operating leases as an expense, and recent changes to FRS 102 move it closer to the IFRS 16 approach. If balance sheet presentation or bank covenants matter to you, discuss the treatment with your accountant before you choose between leasing and buying.

Finance leases are used for almost any business asset with a measurable value and a resale market. Common examples include production machinery, printing and packaging lines, commercial vehicles and trailers, catering and refrigeration equipment, telecoms and IT hardware, and clinical kit such as medical equipment. Older assets can be leased too; our page on used equipment finance explains what lenders look for. Software, installation and fit-out are harder to lease on their own, though some lessors will include a share of them alongside hardware; see our guide to soft asset finance.

A finance lease suits businesses that want the use of an asset for most of its life, value spreading VAT across the term, and are not concerned about owning it at the end. It often appeals to growing companies protecting cash, to businesses that cannot use capital allowances efficiently, and to those who replace equipment on a regular cycle.

It is less suitable if you want to own the asset outright, if you need flexibility to hand it back early (finance leases are hard to exit mid-term), or if the asset is likely to be obsolete long before the primary period ends. Businesses that want the lessor to take residual value risk should look at an operating lease, and those wanting ownership should consider hire purchase.

A straightforward finance lease for a mainstream asset from an established supplier is often decided within a few working days. Larger amounts, specialist or used assets and newer businesses typically take longer, because the lessor may want accounts, a valuation or an inspection. Once approved, documents are signed and the lessor pays the supplier, usually on delivery or installation. Timescales depend on the lender and the case.

The asset itself is the main security, because the lessor owns it throughout the lease and can recover it if rentals are not paid. For limited companies, lessors frequently ask directors for a personal guarantee, particularly where trading history is short or the asset is specialist. Additional security over property is not usually required for standard equipment leasing.

The cost of a finance lease is built into the rentals, which reflect the asset price, the lessor's finance charge, the term and any rentals paid in advance. Agreements may also include a documentation fee at the start and an annual or one-off secondary rental. Compare leases on the total rentals payable across the primary period, the peppercorn terms and the share of sale proceeds you would receive at the end. It is free to enquire; any broker fee is disclosed separately before you proceed.

• Hire purchase: similar monthly cost, but you own the asset at the end and can usually claim capital allowances.
• Equipment finance: our wider overview of the ways businesses fund equipment.
• Asset refinancing: release cash from equipment you already own.
• Unsecured business loans: for mixed purchases that include installation, training or software.