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NEWS - PLANNING
No need to tie up cash in computers
6/27/2001
With the changes to computers since their introduction in 1940, now practically every business needs computers to compete in the marketplace. However, with various leasing options open to businesses, the question is, do we lease or do we buy?
From a tax perspective, the important point about purchasing rather than leasing computers is that the equipment cost goes on to a company's books as an asset.
Capital expenditure items are depreciated over a number of years - at the time, computer hardware was generally depreciated over five years in most countries. In contrast, leasing costs remain off the balance sheet and can be completely written off when they are incurred.
Back in the 1970s and early 1980s, depreciating computer equipment over five years wasn't such a bad deal because there was high inflation and computer systems would retain their value over the depreciation period. This remained true during the early years of the PC revolution, but by the late 1980s, inflation had been tamed in most western countries. More significantly, the pace of PC development accelerated radically, changing the economics of computer purchasing.
Unlike most business assets, during the 1990s PCs lost their value extremely quickly. To understand the implications of this, compare PCs with motor vehicles. If you purchased a new company car in 1995, by 1998 you would have still owned a reasonably nice vehicle.
Had you purchased a state-of-the-art desktop PC in early 1995, by 1998 you'd have a doorstop. Of course, the three-year-old computer would still do everything it was doing at the time of purchase - but it would have had difficulty running 1998's computer applications.
By 1998, the company that bought the vehicle in 1995 would be able to sell it for 40-50 per cent of its original purchase price. Alternatively, if it were a high-end model, it could be passed down the chain to more junior employees. In comparison, by 1998 the company buying a 1995 PC would probably have to pay someone to take it away.
The rapid advancement in technology is only part of the reason a three-year-old business PC has almost no realisable value. During early years, as companies were building up hardware inventories, older machines were recycled in other parts of their respective organisations. By the mid-1990s, the overheads of managing disparate computers - and by extension, software - from different eras far outweighed any savings from reusing pre-loved hardware.
Recognising reality, government now allows businesses to depreciate hardware over just three years. Even so, it can still make sense for companies to move IT equipment off the balance sheet and lease.
Although leasing PC hardware and software is tax effective, this isn't the main justification for its growing popularity with Australia's small and medium-size companies.
In descending order of importance, the main reasons given by organisations choosing to lease equipment are: removing the headache of keeping pace with rapidly changing technology; preserving valuable cash flow and smoothing the support problems associated with managing technology in a small company.
Company tax considerations are only of secondary importance. Yet, there's a less obvious tax-related reason for looking at leasing. One side effect of GST is that it forces companies to focus more on cash flow - preserving cash takes on more importance and leasing keeps cash in a business. At first sight, the company tax benefits look straightforward - lease costs are fully written off in the year incurred while purchases are depreciated. But as a rule, the finance, insurance and other charges more than offset any company tax savings.
This is a consequence of the nature of leasing. When an organisation leases an asset, the asset is sold to a leasing company. In a normal lease, say for a truck, the organisation pays the leasing company for the depreciation in the asset over the life of the lease plus a finance charge.
The problem with an IT lease is that after a three-year period, the original asset is effectively worthless - hence the seemingly high cost of leasing computer hardware.
Companies like Harris Technology, Compaq Computer and Gateway all offer Australian PC leases at similar rates. Over a three-year period, $5,000 worth of computer hardware costs roughly $7,200 in weekly or monthly payments. With the company tax rate at 34 per cent, the net cost to a business is about $4,750. A company buying the same hardware would pay $5,000 up front, then receive tax credits over the next three years.
To make things complicated, the computer market has changed again. Although PCs continue to get faster and drop in price, the more powerful hardware doesn't buy users any tangible benefits. Microsoft Office runs as fast on today's flagship 1.8Ghz PCs as it does on three-year-old Pentium systems. Suddenly, hardware doesn't need to be replaced so quickly - though three-year-old hardware is still virtually unsaleable.
But the real change in the technology-leasing scene comes from left field. While big software companies have always sold customers annual licences to use their software, companies in the PC space are now moving to new pricing schemes.
So far, the ASPs which charge customers fees to use online applications are only beginning to take off, and Microsoft recently started offering Australian and New Zealand customers annual licences for the new version of its Office software. Mark Linton, the Office Product manager at Microsoft Australia, says the subscription offer is being test marketed in this region.
He says: "With a subscription, your software always remains current. We typically release a new version every two years - when that happens you just get a new disc through the post."
To promote the service, Microsoft is charging $299 for the first year, though the price will revert to $359 annually. This compares with $1,289 for a full version of the software and $749 for an upgrade.
Some critics see the move as a crafty way of squeezing more money from the market - they may have a case though at present the cost of subscribing plus the tax advantages point in the opposite direction. The advantages for small business are that an annual licence takes software purchases off the balance sheet and helps cash flow.
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