Lease or buy decision explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
A clinic, a diagnostic centre or a design studio needs a costly machine. It can pay the supplier and own the machine, or it can pay a monthly or yearly rental and hand the machine back later. The right choice is not the one with the lower total of rupees paid, but the one with the lower cost in today's money. This guide sets out the method with an invented diagnostic centre.
List the cash outflows of each option year by year, after tax. For buying: the price, less the tax saved on depreciation, less the sale value at the end. For leasing: the rentals, less the tax saved on them. Discount both at the same rate, usually the after-tax cost of borrowing. Choose the option with the lower present value of net outflows, then check non-financial points such as obsolescence and cash needs.
Leases in plain terms
An operating lease is a rental for a period shorter than the asset's life; the owner of the asset (the lessor) keeps the risks and rewards of ownership, and the user returns the asset. A finance lease runs for most of the asset's life and passes most risks and rewards to the user, who in effect borrows to buy. In a sale and leaseback, a firm sells an asset it owns to a lessor and leases it back, releasing cash. How leases appear in the accounts is dealt with in AS 19 on leases. This article covers the decision, not the accounting.
The cash flows
| Option | Cash flows to include |
|---|---|
| Buy (financed by borrowing) | Price at the start; tax saved on depreciation each year; sale value at the end; maintenance and insurance if the owner bears them |
| Lease | Rental each year; tax saved because rentals are deducted; maintenance if the user bears it |
Costs that are the same under both options, such as maintenance borne by the user in either case, can be left out of the comparison. The tax effect needs care; use an assumed rate and see our income-tax guides for the actual position.
Discount rate. Both options are discounted at the same rate, usually the after-tax cost of borrowing, since leasing displaces a loan. If the loan rate is r and tax rate is t, the after-tax rate is r x (1 - t).
Present value of a stream. PV = sum of cash flow / (1 + rate)^year, as in time value of money. For a firm that lacks a finance head, a virtual CFO can run the comparison before the quote expires.
Worked example: Lifeline Diagnostics
Lifeline Diagnostics, an invented centre, needs an imaging machine costing ₹40 lakh. All of the following are assumptions: life 5 years; sale value ₹4 lakh at the end of year 5 (tax on the sale ignored for simplicity); depreciation by the straight-line method, so (40 - 4) / 5 = ₹7.2 lakh a year; tax rate 25 per cent; borrowing rate 12 per cent; lease rental ₹10 lakh at the end of each year for five years, with the user bearing maintenance either way. These are not current rates or the actual tax rules.
After-tax discount rate = 12 x (1 - 0.25) = 9 per cent. Discount factors at 9 per cent, to three decimals: 0.917, 0.842, 0.772, 0.708, 0.650; their sum is 3.889.
Option 1: buy
Tax saved on depreciation each year = 7.2 x 0.25 = ₹1.8 lakh.
| Year | Cash flow (₹ lakh) | Factor | Present value |
|---|---|---|---|
| 0 | -40.00 (price) | 1.000 | -40.000 |
| 1 | +1.80 | 0.917 | +1.651 |
| 2 | +1.80 | 0.842 | +1.516 |
| 3 | +1.80 | 0.772 | +1.390 |
| 4 | +1.80 | 0.708 | +1.274 |
| 5 | +1.80 + 4.00 = +5.80 | 0.650 | +3.770 |
| Net present value of buying | -30.40 |
(The positive rows add to 9.601; 40 - 9.60 = 30.40.) The present value of the net cost of buying is ₹30.40 lakh.
Option 2: lease
Rental after tax = 10 x (1 - 0.25) = ₹7.5 lakh a year.
| Year | After-tax rental | Factor | Present value |
|---|---|---|---|
| 1 | 7.50 | 0.917 | 6.878 |
| 2 | 7.50 | 0.842 | 6.315 |
| 3 | 7.50 | 0.772 | 5.790 |
| 4 | 7.50 | 0.708 | 5.310 |
| 5 | 7.50 | 0.650 | 4.875 |
| Present value of leasing | 29.17 |
(The rows add to 29.168; check: 7.5 x 3.889 = 29.17.)
Comparison. Leasing costs ₹29.17 lakh in present value against ₹30.40 lakh for buying, so on these assumptions leasing is cheaper by ₹1.23 lakh. The break-even rental, at which the two are equal, is 30.40 / (0.75 x 3.889) = 30.40 / 2.9168 = ₹10.42 lakh a year: if the lessor asks more than that, buying wins.
Sensitivity. The result depends on the rate and the sale value. If the machine can be sold for ₹8 lakh instead of ₹4 lakh, buying gains 4 x 0.650 = ₹2.60 lakh more in present value from the sale, while depreciation falls to (40 - 8) / 5 = ₹6.4 lakh and the tax saved to ₹1.6 lakh a year, which gives back 0.2 x 3.889 = ₹0.78 lakh; buying then costs about 30.40 - 2.60 + 0.78 = ₹28.58 lakh, below the ₹29.17 lakh of leasing, and favours purchase. The owner therefore asks what a used machine of this type is likely to fetch.
What the owner decides. Leasing is cheaper by a small margin, and imaging technology changes quickly, so the lease also limits the risk of obsolescence and preserves cash for other uses. Lifeline's owner leases, provided the lessor agrees on maintenance and an upgrade option, and notes that the small gap of ₹1.23 lakh is within the error of the assumptions.
Non-financial points
- Obsolescence: leasing passes the risk of out-of-date equipment to the lessor.
- Cash preservation: leasing needs little at the start, which matters when funds are tight.
- Control and customisation: an owned machine can be modified or sold.
- Borrowing capacity: a lease may use up some capacity, depending on how it is shown.
- Short horizon: if the machine is needed for only part of its life, leasing avoids a resale.
The same discipline applies to other short-term choices such as outsourcing; see make or buy and other decisions. For project-level choices see capital budgeting.
Common mistakes
- Comparing the total rentals with the price and ignoring timing.
- Discounting at different rates for the two options.
- Forgetting the tax saved on rentals or depreciation, or taking it twice.
- Leaving out the sale value of an owned asset.
- Leaving out costs that differ, such as insurance or maintenance included in the rental.
- Using a stale loan rate or tax rate from an old example.
Need help with an equipment decision?
If you have a lease quote and a purchase quote side by side, our virtual CFO services will compare them at a sensible rate on your own tax position and loan terms, and point out the costs that the quotes leave out. You then decide with the numbers in front of you.
Key takeaways
- Compare the present value of net after-tax outflows of each option.
- Use the same rate for both, usually the after-tax cost of borrowing.
- Include depreciation tax saving and sale value for buying; rentals less tax saving for leasing.
- Test the break-even rental and the sale value.
- Weigh obsolescence and cash needs alongside the figures.
Read next
- Time value of money
- Capital budgeting: payback, NPV, IRR
- Sources of finance for a business
- Make or buy and other short-term decisions
Disclaimer: The methods described are standard cost accounting and financial management techniques. The worked example uses an invented business and invented figures, including any tax, interest or exchange rate, which are assumptions for illustration and not current rates. Where the article refers to a legal requirement, the linked guide and the official text should be checked. This article is general information, not legal advice; check the official text before acting.