Finance Lease Explained

What Is a Finance Lease?

A finance lease is a rental agreement where a financier purchases an asset and leases it to your business for an agreed term. Unlike a chattel mortgage, the financier owns the asset during the term. At the end, you typically have the option to purchase it for the residual value.

Finance leases are sometimes called "capital leases" and are popular with businesses that want to deduct the full lease payment as a tax deduction while deferring the GST obligation.

How a Finance Lease Works

Choose your asset — new or used equipment, vehicle, or machinery
Apply for a finance lease — through a bank, lender, or broker
Financier buys the asset — and leases it to you for the agreed term
You use the asset — as if you own it, but the financier holds title
Make regular lease payments — fixed monthly payments including a built-in residual/balloon
End of term: pay the residual to purchase, refinance, return the asset, or trade up

ATO Minimum Residual Values

For finance leases, the ATO sets minimum residual values that determine the lowest balloon amount you can set. These ensure you can't fully deduct the asset's cost through lease payments alone.

Lease Term	Minimum Residual (% of Original Cost)
1 year	65%
2 years	45%
3 years	30%
4 years	20%
5 years	15%

You can set a higher residual, but not lower. This is a key difference from chattel mortgages, which have no ATO-mandated minimum.

Tax Treatment

Lease Payments

Each lease payment is 100% tax-deductible as a business expense. You don't separately claim interest or depreciation — the full payment is the deduction.

GST

GST is charged on each lease payment (not upfront). You claim GST credits progressively on each payment through your BAS. This contrasts with chattel mortgages, where you claim the full GST credit at purchase.

No Depreciation

Because the financier owns the asset, you don't claim depreciation. Your tax deduction comes from the lease payments themselves.

Who Does a Finance Lease Suit?

Businesses not registered for GST — no upfront GST credit to miss out on
Companies wanting simple tax treatment — one deduction per payment, no depreciation schedules
Businesses that upgrade regularly — return or trade the asset at end of term
Operators who want lower monthly repayments — mandatory residual reduces payments
Companies managing balance sheet presentation — though AASB 16 now requires most leases on-balance sheet for reporting entities

Pros & Cons

Pros	Cons
100% of lease payment is tax-deductible	No upfront GST credit — GST claimed progressively
Lower monthly payments (due to mandatory residual)	ATO minimum residuals apply — mandatory balloon
Simple tax treatment — no depreciation schedule	Don't own the asset until residual is paid
Flexible end-of-term options	Can't claim instant asset write-off
Good for regular asset replacement cycles	May pay more total interest over the term

Finance Lease vs Other Structures

Frequently Asked Questions

No. At the end of the term, you can pay the residual to purchase, refinance the residual, return the asset, or use the equity to upgrade. You're not locked into purchasing.

Yes. You can set a higher residual to reduce monthly payments further. You just can't go below the ATO minimum for the lease term.

No. A finance lease transfers most risks and rewards of ownership to you (the lessee), and you'll typically purchase the asset at the end. An operating lease is more like renting — you return the asset. Learn about operating leases →