Lease use is both significant and widespread across European firms. In 2003, it accounted for more than 14% of gross fixed capital formation in Europe, and new business amounted to 193 billion euros (Leaseurope, 2003). The UK accounted for 17% of total European leasing activity, coming second to Germany (22%) and matching the level undertaken in Italy. Why do firms obtain the use of business assets through leasing, rather than borrowing to finance purchase?
A range of theoretical reasons for leasing, such as accounting treatment, tax savings, borrowing capacity, repayment and risk sharing, exist in the literature. However, related empirical evidence generated via survey and regression modelling is incomplete for several reasons. First, the majority of UK studies providing direct evidence through survey investigation were conducted before the introduction of accounting regulation and prior to the current tax status. The nature of lease agreements has altered over time. ‘On-balance sheet’ finance leases provided the focus for the majority of prior research and such leases are now in relative decline. ‘Off-balance sheet’ operating leases appear to be a growth market, providing a significant source of finance for UK firms.
For example, for the top 100 UK listed companies 2002/03 year-ends, the median ratio of operating lease liability to debt was estimated at 0.11, and the median ratio of operating lease liability to finance liability was 6.2 (Beattie, Goodacre and Thomson, 2004). Second, studies that provide indirect evidence by investigating the characteristics of UK leasing firms are limited, both in number and in the extent to which qualitative reasons can be investigated. Third, UK findings also appear to conflict with similar studies of US firms. However, as Bancel and Mittoo (2004) highlight, managerial motivations are unlikely to remain static, creating difficulties in interpreting evidence from studies conducted in different time periods and addressing different aspects of the leasing decision.
Historically, leasing use has been significantly attributed to its ‘off-balance sheet’ accounting treatment. If this explains the use of operating leases in the current climate, then the role of leasing in future financing decisions may change if this ‘off-balance sheet’ treatment is removed. Many accounting standard-setting bodies have considered this option. In 1996, the G4+1 group published a report (McGregor, 1996) which formed the basis of a discussion paper in the UK, ‘Leases: implementation of a new approach’ (ASB, 1999). It is proposed that all leases should be recognised on the balance sheet rather than just finance leases.
The UK is currently undertaking a project on lease accounting to inform the International Accounting Standards Board (IASB website, visited April 2005). The future recognition of all lease agreements ‘on-balance sheet’ is not beyond the realms of possibility. Leasing use has also historically been associated with tax treatment through legal ownership, with the right to claim capital tax allowances remaining with the lessor. Tax treatment now looks set to change dramatically with the Inland Revenue intending to switch the award of capital tax allowances from lessors to lessees in a financing arrangement, as part of a reform of the UK corporation tax system (HMSO, 2003).
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The Role of Leasing in UK Corporate Financing Decisions
