When Australian businesses look beyond outright purchase and chattel mortgages to fund their equipment needs, leasing is often the next consideration. But “leasing” isn’t a single product. There are two fundamentally different structures that serve very different business purposes, and choosing the wrong one can cost you significantly in tax benefits, cash flow and flexibility.
A finance lease and an operating lease may sound similar, but they differ in ownership, tax treatment, accounting treatment, risk allocation and end-of-term options. Understanding these differences is essential for making the right finance decision for your specific business situation.
At Mortgage & Finance Advisory, we help businesses across Geelong, the Surf Coast, Melbourne and regional Victoria compare the full range of equipment finance options, including both lease types. This guide breaks down the key differences so you can make an informed choice or, better still, have a productive conversation with your broker and accountant about which structure delivers the best outcome for your needs.
A finance lease (sometimes called a capital lease) is an arrangement where the lender (lessor) purchases the asset and leases it to your business (the lessee) for a fixed term. While the lender technically owns the asset during the lease period, the arrangement is structured so that you bear substantially all the risks and benefits of ownership.
You select the equipment you need and agree on the purchase price with the supplier. The leasing company purchases the asset and leases it to your business for an agreed term (typically 2-7 years). You make regular lease payments throughout the term, which include a finance charge (similar to interest). At the end of the lease, you pay a pre-agreed residual value (typically 10-30% of the original cost) to take ownership of the asset. Alternatively, you can extend the lease, return the asset, or upgrade to newer equipment.
Under a finance lease, the lessee typically cannot claim depreciation on the asset (because the lessor technically owns it). Instead, the lease payments themselves are tax-deductible as a business expense. GST is included in each lease payment and can be claimed as an input tax credit on each BAS, but unlike a chattel mortgage, you don’t get the full GST credit upfront.
Under current Australian Accounting Standards (AASB 16), finance leases are recognised on the balance sheet as a right-of-use asset and a corresponding lease liability. This means the lease appears as both an asset and a debt on your balance sheet, which can affect financial ratios and may be relevant if you’re seeking additional finance or reporting to stakeholders.
An operating lease is fundamentally different from a finance lease. It’s essentially a long-term rental agreement. The lessor retains ownership and the associated risks, while you pay for the use of the asset during the lease term.
The leasing company purchases the asset and makes it available for your use for a fixed period. You make regular rental payments throughout the term, which are typically lower than finance lease payments (because you’re not paying down the full value). At the end of the lease, you return the asset to the lessor. There is no residual payment or purchase obligation. Some operating leases offer the option to extend the lease or negotiate a purchase, but there’s no obligation or pre-agreed price.
Operating lease payments are fully tax-deductible as a business operating expense. GST on each payment is claimable on your BAS. The simplicity of the tax treatment is one of the operating lease’s attractions: there’s no depreciation to track, no residual value calculations, and no balloon payment tax implications.
Under AASB 16 (which applies to most reporting entities), operating leases are now also recognised on the balance sheet as right-of-use assets and lease liabilities, similar to finance leases. However, for small businesses that don’t report under full AASB standards, operating lease payments may simply be recorded as an expense, keeping the obligation off the balance sheet.
| Feature | Finance Lease | Operating Lease |
|---|---|---|
| Ownership Intent | You intend to own at end of term | You intend to return at end of term |
| Lease Term | Covers most of the asset’s useful life | Typically shorter than asset’s useful life |
| Monthly Payments | Higher (paying toward ownership) | Lower (paying for use only) |
| Residual Value Risk | You bear the risk (residual payment) | Lessor bears the risk |
| End of Term | Pay residual to own, extend, or return | Return the asset |
| Maintenance | Your responsibility | Often included or lessor’s responsibility |
| Tax Deduction | Lease payments deductible | Lease payments deductible |
| GST | Claimed on each payment | Claimed on each payment |
| Instant Write-Off | Generally not available (lessor owns) | Not available (lessor owns) |
| Best For | Assets you want to own long-term | Assets that become obsolete or need regular upgrading |
A finance lease is generally the better choice when you want to own the asset at the end of the term, the asset has a long useful life and will retain value, you don’t want to pay the full purchase price upfront (but do want an ownership pathway), your business benefits from lower monthly payments during the lease term (compared to a chattel mortgage with no balloon), and you’re comfortable with the residual value obligation at the end.
Common assets financed via finance leases include heavy machinery with long productive lives, commercial vehicles for long-term fleet use, manufacturing and production equipment, and medical and dental equipment.
An operating lease is generally preferred when the asset becomes obsolete or outdated quickly (like IT equipment), you want to upgrade to the latest technology regularly, your business needs are uncertain or project-based, you prefer lower monthly payments with no end-of-term obligation, you want to avoid residual value risk, and maintenance and servicing inclusion is important.
Operating leases are particularly popular for IT hardware and infrastructure, office equipment and furniture, short-term project vehicles, and technology that evolves rapidly.
A Geelong medical practice needed to acquire a $180,000 diagnostic imaging system. They were initially considering a finance lease, but after discussing their plans we identified that the technology in this particular field advances rapidly, with new models delivering significantly better outcomes every 4-5 years. We recommended an operating lease over 4 years at $4,200 per month, lower than the finance lease option of $4,850 per month (which included a 15% residual). At the end of 4 years, the practice returned the unit and leased the latest model, giving their patients access to the newest technology without having to sell the old equipment or paying a residual on outdated technology. The monthly savings of $650 over the lease term totalled $31,200, which the practice redirected toward staff training.
For many Australian businesses, particularly those registered for GST, a chattel mortgage often delivers a better overall outcome than either type of lease. The chattel mortgage gives you ownership from day one, allows you to claim the full GST credit upfront, provides access to both depreciation and interest deductions, and may qualify for the instant asset write-off. The main scenarios where a lease is preferable are when you specifically don’t want ownership (operating lease) or when you prefer lower ongoing payments with a deferred purchase option (finance lease).
The best lease type often depends on your industry and how equipment is used within it. Here’s how different sectors typically approach the finance lease vs operating lease decision.
Heavy earthmoving equipment, cranes and drilling rigs typically have long useful lives and hold their value well. Most construction businesses prefer finance leases or chattel mortgages because they intend to own these assets long-term, the equipment maintains strong resale value, and the assets generate revenue for 10-15+ years. Operating leases are sometimes used for equipment needed for specific project durations, allowing the business to return the machinery once the project is complete without residual value concerns.
Medical equipment presents an interesting case. Diagnostic imaging systems, surgical equipment and specialist medical devices can cost hundreds of thousands of dollars but may become clinically outdated within 5-7 years as technology advances. Many medical practices use operating leases for technology-dependent equipment, allowing them to upgrade to the latest models at each lease renewal. Conversely, equipment with longer clinical relevance (dental chairs, examination tables, sterilisation equipment) is more commonly financed via finance leases or chattel mortgages.
Fleet operators often use a mix of both lease types. Prime movers and specialist vehicles that will be operated for their full useful life are typically financed via finance leases or chattel mortgages. Delivery vans or short-term project vehicles may be placed on operating leases for maximum flexibility. Large fleet operators sometimes use novated or fleet-managed operating leases that include maintenance, registration and insurance in a single monthly payment.
IT equipment is the most common candidate for operating leases because technology evolves rapidly. A server that’s state-of-the-art today may be inadequate within 3-4 years. Operating leases allow businesses to refresh their IT infrastructure regularly without worrying about disposing of obsolete hardware. Many IT operating leases include maintenance, software updates and end-of-life data destruction as part of the package.
To truly compare finance leases and operating leases, you need to look beyond the monthly payment and consider the total cost over the period you’ll use the asset.
Let’s use a $200,000 piece of equipment as an example, assuming a 5-year usage period.
| Cost Component | Finance Lease | Operating Lease |
|---|---|---|
| Monthly Payment | ~$3,920 (with 15% residual) | ~$3,500 |
| Total Payments (60 months) | $235,200 | $210,000 |
| Residual Payment | $30,000 | $0 |
| Total Cash Outlay | $265,200 | $210,000 |
| Asset Owned at End? | Yes, worth ~$50,000-$80,000 | No, nothing retained |
| Net Cost After Resale | $185,200 – $215,200 | $210,000 |
This example illustrates an important point: the finance lease has a higher total cash outlay, but if the asset retains reasonable value, the net cost after resale can be lower than the operating lease. The operating lease’s advantage is certainty: you know exactly what it will cost with no residual risk. The finance lease carries upside potential if the asset holds value, but also downside risk if it doesn’t.
As your business evolves, the right lease type may change. It’s not uncommon for businesses to start with operating leases when they’re new and uncertain about long-term needs, then transition to finance leases or chattel mortgages as they grow and can better predict their equipment requirements.
Similarly, businesses that have traditionally purchased or finance-leased their equipment sometimes shift to operating leases for specific asset categories as they recognise the benefits of regular technology refreshes without residual value management.
Your finance broker can help you assess which structure is optimal for each asset category and adjust your approach as your business needs evolve. There’s no rule saying you need to use the same finance structure for everything. Many businesses use a mix of chattel mortgages, finance leases and operating leases across their different asset types, choosing the best structure for each specific situation.
Both finance and operating leases can typically be terminated early, but there will be costs involved. Finance leases usually require payment of the remaining lease amounts plus the residual. Operating leases may have early termination fees specified in the agreement. Always check the early termination terms before signing any lease agreement.
Under a finance lease, the lessee (you) is responsible for all maintenance and running costs, just as if you owned the asset. Under an operating lease, maintenance responsibilities vary. Some operating leases include maintenance as part of the package, while others make it the lessee’s responsibility. This is an important point to clarify before signing.
Under a finance lease, you generally have more freedom to modify the asset since you intend to own it. Under an operating lease, modifications are typically restricted because the asset must be returned in acceptable condition. Any modifications under an operating lease usually require the lessor’s written approval.
Under both types, you’re typically required to maintain comprehensive insurance. If the asset is written off by insurance, the payout goes to the lessor to settle the lease obligation, with any surplus returned to you. If the payout doesn’t cover the outstanding lease amount, you may be liable for the shortfall.
Operating leases typically have lower monthly payments because you’re only paying for the use of the asset, not its full value. However, you end the lease with no asset. A finance lease has higher total payments (including the residual) but you end up owning the asset. The “better deal” depends entirely on whether ownership has value for your business.
We’ll compare all finance options side by side and recommend the structure that delivers the best outcome for your business. Free, no-obligation consultation.
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About the Author
Melanie McNaughton is the founder of Mortgage & Finance Advisory, based in Geelong, Victoria. Melanie helps businesses across Geelong, the Surf Coast, Melbourne and regional Victoria choose the right equipment finance structure, whether that’s a chattel mortgage, finance lease, operating lease or other product. Contact Melanie on 03 9020 2699 for obligation-free advice on your equipment finance options.
