Purchase or Lease: Which is Favorable?

Purchase or Lease: Which is Favorable?

For Indian businesses in FY 2026-27, the purchase-versus-lease decision comes down to three variables: how fast the asset becomes obsolete, your effective tax rate, and whether your balance sheet can absorb additional debt. Purchase wins on lifetime cost for long-life, collateralisable assets where depreciation tax shields and residual value together beat cumulative rentals. Lease wins on flexibility and early-year deductions for technology, vehicles, and capital-constrained businesses where working capital preservation outweighs lifetime cost. This article walks through the mechanics, the tax arithmetic, and a step-by-step framework so you can make the call before you sign anything.

How Each Structure Works — and What the Law Says

A purchase transfers full ownership to you. You pay the full consideration (or finance it via a term loan or hire purchase), register the asset in your name, and carry it on your balance sheet at cost. You bear all the risk of obsolescence, damage, and residual value fluctuation — but you also capture the upside if the asset retains or appreciates in value.

A lease is a right-to-use arrangement. The lessor (owner) retains legal title; you (the lessee) pay periodic rentals for the right to use the asset for an agreed period. Indian law recognises two broad categories:

• Finance lease: substantially transfers all risks and rewards of ownership to the lessee. A 5-year equipment lease with a nominal buyout option at end of term is the classic example — economically, a disguised purchase.
• Operating lease: a shorter-term or cancellable arrangement where ownership risks stay with the lessor. A 12-month laptop contract or a month-to-month vehicle rental are typical cases.

Hire purchase sits in between — ownership transfers automatically on payment of the final instalment. The asset appears on the buyer's books from day one, and depreciation is claimed by the buyer, not the financier.

For income-tax purposes, the classification still governs under the Income Tax Act, 1961: depreciation under Section 32 flows to the owner (or the finance lessee where economic ownership lies with them), while operating lease rentals are deductible as business expenditure under Section 37(1).

Ind AS 116: Why Your Lease Is No Longer Off the Balance Sheet

Before April 2019, Indian companies structured operating leases to keep entire asset classes — car fleets, server racks, office fit-outs — off their balance sheets entirely. Ind AS 116 (Leases, mandatory from 1 April 2019 for Ind AS-compliant companies) closed that door.

What Ind AS 116 Requires

Every lessee must now recognise:

1. A Right-of-Use (ROU) asset — reflecting the right to use the underlying asset over the lease term, measured at the present value of future payments plus initial direct costs.
2. A Lease liability — the present value of outstanding lease payments, discounted at the rate implicit in the lease or the lessee's incremental borrowing rate.

Two narrow exemptions exist:

• Leases with a remaining term of 12 months or less (short-term leases)
• Leases for low-value assets — Ind AS 116's basis for conclusions references assets with a new value below approximately USD 5,000, broadly Rs. 4 lakh at current rates

The Balance Sheet and P&L Impact

A company leasing 40 laptops at Rs. 4,000/month each for 3 years would previously have shown zero additional asset and zero additional liability. Under Ind AS 116, it now recognises a ROU asset of approximately Rs. 46 lakh and a matching lease liability on Day 1 — inflating both total assets and total debt.

The P&L impact is equally significant:

• The straight-line rental expense is replaced by depreciation on the ROU asset plus interest on the lease liability
• In early years, the combined P&L charge exceeds the old rental amount (interest front-loading)
• EBITDA improves because lease payments (previously above the EBITDA line as operating expense) are reclassified as depreciation and interest (both below the EBITDA line)

Critical flag for loan covenants: If your bank facility uses a Debt/EBITDA or Total Debt/Net Worth covenant, Ind AS 116 can push you toward a technical breach without any real change in your business operations. Review facility agreements before committing to any large multi-year lease.

Tax Treatment Differs from Books

The Income Tax Act does not automatically follow Ind AS 116. For tax purposes, an operating lease rental remains fully deductible under Section 37(1) as incurred. You cannot claim tax depreciation on an Ind AS 116 ROU asset for an operating lease — you do not own the underlying asset. This creates a timing difference between book profit and taxable income that your deferred tax working must capture in every period.

Section 32 Depreciation: The Purchase Tax Shield in Detail

When you purchase an asset, Section 32 of the Income Tax Act gives you a Written Down Value (WDV) depreciation deduction each year. Key rates applicable for AY 2027-28:

Additional Depreciation Under Section 32(1)(iia)

Eligible manufacturers and power generation companies can claim an additional 20% of actual cost on new plant and machinery in the year of acquisition — stacked on top of the regular rate. For qualifying manufacturing plant, Year 1 depreciation effectively becomes 35% (15% + 20%) of cost.

However, companies that have opted for the concessional rate of 22% under Section 115BAA (or 15% under Section 115BAB for new manufacturing companies) cannot claim additional depreciation. If you have opted into either concessional regime, remove this benefit from your purchase NPV model entirely.

The Half-Year Rule — Often Missed

Where an asset is put to use for fewer than 180 days in the year of acquisition, only 50% of the applicable depreciation rate applies. An asset purchased in January 2027 earns only 7.5% WDV (half of 15%) in FY 2026-27 rather than the full 15%. Timing the acquisition in the April–September window doubles your Year 1 tax shield for the same asset at the same price.

GST on Lease Rentals — Credits, Blocks, and the Vehicle Trap

GST treatment is where lease economics most often go wrong in practice, because finance teams assume all GST paid is recoverable. It is not.

Operating lease of movable assets:

• Treated as a supply of services under the CGST Act, 2017
• GST rate: typically 18% for most movable business assets
• Input Tax Credit (ITC) is available where the asset is used exclusively for taxable supplies — subject to blocked credit provisions

Section 17(5) CGST Act: The Motor Vehicle Block

ITC on motor vehicles with seating capacity of 13 or fewer persons (including the driver) is categorically blocked unless the vehicle is used for:

• Further supply of motor vehicles (dealer/manufacturer)
• Transportation of passengers (taxi operator, bus service)
• Imparting driving training

What this means in practice: If you lease sedans for your executives or a fleet of SUVs for your sales team, the GST on every lease rental is a dead cost. For a Rs. 22,000/month vehicle lease, the 18% GST adds Rs. 3,960/month — Rs. 47,520 per car per year — that you cannot recover. Over a 48-month fleet contract covering 10 cars, that is Rs. 19,00,800 of unrecoverable GST that must sit inside your lease cost comparison.

Pre-Signing GST Checklist

1. What HSN/SAC code is the lessor invoicing under — goods lease or services?
2. Is the asset category covered by Section 17(5) blocked credits?
3. Is the lessor a GST-registered entity issuing a valid tax invoice in GSTR-1?
4. Will the asset be used exclusively for taxable outward supplies?
5. Has your CA confirmed ITC eligibility in writing for this specific asset and use case?

Worked Example: Rs. 15 Lakh Manufacturing Machine, Five Years

A mid-size fabrication unit is evaluating a CNC grinding machine costing Rs. 15,00,000 with an expected economic life of 8–10 years. It needs the machine for at least 5 years.

Assumptions used:

• Effective tax rate: 25% (domestic company, default regime, approximate combined rate)
• Cost of debt: 11% p.a.
• Purchase: 100% financed via a term loan at 11% over 60 months
• Lease: operating lease at Rs. 35,000/month (Rs. 4,20,000/year; lessor bundles insurance and routine maintenance)
• Residual market value of the machine after 5 years: Rs. 4,50,000 (conservative for a maintained CNC asset)
• Asset qualifies for additional depreciation (company is in default regime, manufacturing activity confirmed)
• GST on lease rentals: creditable (industrial machinery used for taxable manufacturing output)

Purchase Path

Term loan at 11% over 60 months on Rs. 15,00,000: Monthly EMI ≈ Rs. 32,610 | Total repayment over 5 years = Rs. 19,56,600 | Total interest = Rs. 4,56,600

WDV depreciation schedule at 15% (plus 20% additional in Year 1):

Year 1: Rs. 2,25,000 (15%) + Rs. 3,00,000 (20% additional on Rs. 15,00,000 cost) = Rs. 5,25,000

Tax saving on interest (Section 37(1)): Rs. 4,56,600 × 25% = Rs. 1,14,150 Registration and incidentals: Rs. 50,000 (estimated)

Net purchase cost calculation:

Lease Path

The Verdict — and When It Flips

Purchase saves Rs. 3,80,312 over 5 years in this scenario — approximately 19% lower lifetime cost, driven heavily by the Year 1 additional depreciation benefit.

Now remove the additional depreciation (e.g., company has opted for Section 115BAA at 22% and loses both the additional depreciation and the higher rate shield). The purchase's depreciation tax saving falls sharply, and the effective 5-year purchase cost rises to approximately Rs. 14,50,000 — much closer to the lease option.

Now remove the residual value (e.g., the machine is highly specialised with near-zero resale). Effective purchase cost rises to Rs. 16,44,688 versus lease at Rs. 15,75,000 — lease wins.

And if the GST on lease rentals is blocked (motor vehicle scenario):

• Lease: Rs. 21,00,000 + Rs. 3,78,000 unrecoverable GST − Rs. 5,25,000 tax saving = Rs. 19,53,000
• Purchase clearly wins by a wide margin.

The worked example's lesson: No single number changes the outcome — it is the combination of your tax regime, asset residual value, and GST creditability that determines the winner.

When Purchase is the Right Call

• Long economic life, stable utility — heavy industrial plant, factory buildings, and agricultural equipment that do not become functionally obsolete within your planning horizon
• Strong secondary market — assets with predictable resale value (commercial vehicles with established auction markets, standard CNC machinery, gold jewellery tools) allow meaningful capital recovery at exit
• Collateral requirements — only assets you legally own can be pledged as security for working capital or project finance facilities; leasing erodes tangible collateral and borrowing headroom
• Additional depreciation eligibility — when Section 32(1)(iia) applies and you are in the default regime, Year 1 depreciation of 35% on qualifying plant can generate a tax saving that approaches the entire first year's lease outflow
• State industrial policy or PLI scheme linkage — several state investment promotion policies and Central PLI (Production-Linked Incentive) schemes explicitly require capital expenditure to involve asset ownership, not lease rights, for eligibility; check scheme guidelines before leasing qualifying assets
• Regulatory capacity credentials — hospitals seeking NABH accreditation, engineering consultancies responding to government tenders, and NABL-accredited testing labs often need to demonstrate owned equipment in their quality documentation

When Lease is the Right Call

• Rapid technological obsolescence — laptops, servers, AI inference accelerators, scientific instruments, and telecom hardware; the asset you buy today may be functionally obsolete in 24–30 months; a lease with a contractual refresh clause ensures you never operate on outdated technology
• Early-stage, capital-constrained businesses — preserving Rs. 15–50 lakh of working capital in the first 24 months of operations can extend runway by a critical quarter; converting capex to opex has a direct impact on burn rate and investor metrics
• Variable or seasonal demand — event management firms, agricultural input distributors, and hospitality businesses benefit from the ability to return or downscale leased assets during off-peak periods rather than carrying dead capital on the balance sheet
• Passenger vehicles for staff — given the Section 17(5) GST ITC block, the maintenance and insurance overhead, and the resale market friction, most businesses above a basic headcount threshold are better served by a fleet management lease that bundles all costs into a single tax-deductible monthly rental
• Non-Ind AS companies preserving balance-sheet ratios — smaller companies (below the Ind AS applicability threshold) that follow AS 19 can still keep operating leases off their balance sheets; this keeps Debt/Net Worth ratios clean for bank borrowing assessments and working capital renewal
• Short project lifecycles — if an asset is needed for a defined 2–3 year project, owning it creates a disposal problem at project end; a lease aligned to project duration is the structurally cleaner solution

Common Mistakes and Pitfalls to Avoid

1. Treating GST on vehicle leases as creditable without checking Section 17(5) This is the single most common and most expensive error. Finance teams see a GST invoice and reflexively book ITC. For passenger car leases under most commercial arrangements, that ITC is blocked. Build the full 18% GST into your lease cost before comparing it to purchase. On a 10-car fleet at Rs. 18,000/month per car, unrecoverable GST costs Rs. 38,880/month — nearly Rs. 4.7 lakh per year.

2. Ignoring the half-year depreciation rule on late-year purchases Buying significant plant in January or February means your Year 1 tax shield is cut by 50% because the asset is in use for fewer than 180 days in the financial year. If you can pull the purchase forward to between April and September, you double the Year 1 deduction on the same asset at the same price. On a Rs. 15 lakh machine, this difference is Rs. 1,31,250 in Year 1 tax saving versus Rs. 65,625 — a Rs. 65,625 swing from timing alone.

3. Copying Ind AS 116 book depreciation into the income tax computation If your accounts recognise a ROU asset and you are an operating lessee, the income tax computation must not show depreciation on the ROU asset. It should show the actual rental paid as a deduction under Section 37(1). Mixing the two creates an error in the advance tax calculation and can lead to interest under Sections 234B and 234C.

4. Not stress-testing the lease for early exit Most businesses sign 36–60 month leases assuming stable operations. An unexpected pivot, a downsizing, or a market contraction at month 20 triggers the exit clause — often 6 to 12 months of residual rentals as liquidated damages. Probability-weight this cost into your lease NPV, particularly for technology assets where the chance of an upgrade or structural change in the business is high.

5. Missing additional depreciation eligibility — or incorrectly claiming it under 115BAA Manufacturing businesses in the default tax regime frequently under-claim Section 32(1)(iia) because the qualifying conditions (new asset, manufacturing or production activity, not motor vehicle or office appliance) are not systematically reviewed. Conversely, businesses that opted for Section 115BAA to benefit from the 22% rate sometimes continue claiming additional depreciation in error — which is disallowed and attracts reassessment risk.

6. Accepting ambiguous residual value terms in finance leases A finance lease structured to transfer economic ownership must specify the buyout price clearly — ideally a nominal Rs. 1 or a fixed nominal sum. Ambiguous clauses ("market value at expiry" or "as mutually agreed") leave the lessee exposed to disputes, protracted negotiations, and the embarrassing scenario of continuing to pay monthly rentals long after the economic use period has ended.

A Step-by-Step Decision Framework

Step 1 — Define the asset life and your usage horizon How long will you realistically use this asset? As a rule of thumb, if your intended usage period is less than half the asset's economic life, lean toward leasing.

Step 2 — Determine the correct depreciation rates Check Appendix I to the Income Tax Rules for tax rates; check Schedule II of the Companies Act 2013 for book depreciation life. Note whether additional depreciation applies and whether your current tax regime allows it.

Step 3 — Confirm your tax regime Are you in the default regime (25.17% for domestic companies above Rs. 10 cr turnover with surcharge and cess) or the concessional Section 115BAA/115BAB regime? This changes the effective depreciation shield significantly.

Step 4 — Compute total post-tax cash outflows under purchase Include: full purchase price (or loan principal + total interest), registration and stamp charges, insurance (if not bundled in lease), and maintenance — net of depreciation tax shield and probability-adjusted residual value recovery.

Step 5 — Compute total post-tax cash outflows under lease Include: all rentals over the lease term, GST on rentals (only the non-creditable portion based on your Section 17(5) analysis), any up-front security deposit (time-value-of-money adjusted), and a probability-weighted early exit penalty.

Step 6 — Discount both streams at your cost of capital Use your weighted average cost of capital or your marginal borrowing rate as the discount rate. The option with the lower net present value of outflows wins on pure financial terms.

Step 7 — Apply qualitative overlays Score each of the following factors 1–5 (1 = favours purchase, 5 = favours lease): obsolescence risk, collateral need, balance sheet optics under existing loan covenants, flexibility requirement, and management bandwidth for asset ownership. If qualitative scores are decisive, they can and should override a marginal financial difference.

Step 8 — Document the decision For Ind AS companies, document your assessment of whether the arrangement constitutes a lease under Ind AS 116 — specifically: Is there an identified asset? Does the supplier have a substantive right to substitute it? Do you have the right to obtain substantially all economic benefits and the right to direct its use? This documentation feeds directly into your financial statement disclosure and protects the assessment from audit challenge.

Key Takeaways

• Purchase delivers lower lifetime cost for long-life, stable assets with a viable resale market — the advantage is amplified materially when Section 32(1)(iia) additional depreciation is available to manufacturers in the default tax regime.
• Lease preserves working capital and delivers better early-year tax deductions for fast-obsolescence assets; it is structurally superior for capital-constrained businesses, technology-heavy operations, and short project cycles.
• Ind AS 116 has eliminated the balance-sheet advantage of operating leases for listed and large companies — model the ROU asset and lease liability explicitly when assessing the impact on loan covenants, Debt/EBITDA ratios, and banking relationships.
• GST blocked credits under Section 17(5) CGST Act make passenger vehicle leases materially more expensive than headline rental rates suggest; always confirm ITC eligibility asset by asset before signing a fleet lease.
• The half-year depreciation rule can reduce your Year 1 tax shield by 50% on purchases made between October and March — timing acquisitions in the April–September window is a simple, high-value optimisation.
• Section 115BAA optees lose additional depreciation — if your company has moved to the 22% concessional regime, remove additional depreciation from your purchase NPV model to avoid overstating the purchase advantage.
• Run the NPV comparison with your actual cost of capital, actual effective tax rate, and a conservative estimate of residual value — generic rules of thumb are not reliable for decisions involving Rs. 10 lakh or more of committed capital.