What Small Business Owners Should Know about Leasing vs Buying their Car, Corporate Ownership of Vehicles and Deducting Car Expenses

Small business owners who require a vehicle to carry on their businesses are happily able to benefit from a tax deduction relating to the business use of their cars.  Given the potential for abuse, the tax rules for deducting these expenses are fairly specific and extend to the definition of business use, types of expenses that may be claimed, methods of calculating the deduction and whether you buy or lease your car.  While the decision to buy or lease a car can be difficult enough for individuals (a Porsche is so much more affordable when you lease!), small business owners have an even harder time as the tax implications of the transaction have to be taken into consideration.

 

The fundamental difference between leasing and buying i.e. ownership is a key consideration when making the decision.  From a financial standpoint, leasing requires a lower cash outlay even if you finance the purchase of your car.  A car that costs $30,000 to buy may only cost $15,000 to lease over a 3 year period.  Of course, at the end of the three years, the lease period will end and you will be in the market for a new car (so you might want to ask yourself how much you like change).  Also, leasing is almost always more expensive in the long run as a car can have a life that extends many years beyond the financing period (although you probably want to make the acquaintance of a good mechanic).

From a tax standpoint:

The limit on the monthly lease payment that you can deduct is $800 per month.  This works out to a maximum of $9,600 of expense that is tax deductible annually.

The limit for deductibility for a purchased vehicle is $30,000.   It is important to note that this amount cannot be deducted in its entirety but must be depreciated at 30% (on a declining balance basis).  Furthermore, you are only allowed to deduct 50% of the depreciation (known as the half year rule) in the year of purchase.  This equates to a $4,500 deduction in year 1.  In year 2, the depreciation expense is 30% of the undepreciated balance ($30.000 less $4,500 = $25,500), which would be $7,650.  You are also allowed to deduct any interest paid on financing the vehicle.  The interest rate can usually be found in the financing contract and calculated over the period of the financing.  The maximum amount of interest that can be deducted is $300.

All repairs and maintenance, insurance, registration and other operating expenses may be deducted for both lease and purchase.  Keep in mind that only % used for business can be deducted.  This should be calculated by maintaining an automobile log (there are apps for that) where you note the date, kms driven and business reasons for the trip.

If you are incorporated, you have the option of having your company purchase the car.  The main benefit of using this option is that the company maintains liability for the car (unless a personal guarantee is required) and payments can be made directly through the company.   Keep in mind that personal use of the car will have to be calculated and reflected as a taxable benefit on the owner-employer’s T4 or reimbursed to the company, which ultimately leads to more paperwork . It is important to note that unless you use your car primarily for business, it will usually be more expensive (i.e. higher taxes in the form of a taxable benefit) to have the company purchase the car than to purchase it personally.

Incorporated entities are also allowed to reimburse employee-owners based on kms driven which is approximately $0.50 per km (exact amounts found here).  In this case there is no difference between leasing vs buying as the amount that can be deducted is based entirely on a reasonable allowance per km driven. 

There is no magic answer to the lease vs buy question for small business owners.  Buying is generally more cost effective, although the tax deduction also tends to be lower.  If you use a per km allowance to reimburse yourself from your corporation (unincorporated small business cannot use this method as you are essentially reimbursing yourself), you can save yourself paperwork, however in a year with high operating expenses (eg. Repairs) you may be missing out on a higher deduction.  If you aren’t averse to excel spreadsheets or you have good accounting software and/or a bookkeeper, it might make sense to keep track of both and use the more beneficial method to ensure the lowest tax liability at the end of year