Skip to content

Goods and Services Tax (GST) and Corporate Tax Planning · Tax Planning and Managerial Decisions

Own or Lease Decision in Tax Planning

Updated 11 October 2026 · Fact-checked

The own or lease decision compares the present value of your after-tax cash outflows under each option. For owning, deduct the depreciation tax shield from the cost. For leasing, deduct the tax saved on rentals. Discount at the after-tax cost of borrowing and choose the option with the lower net present cost.

Understand Own or Lease Decision

A company that needs a machine can buy it or take it on lease. Both routes give the same use of the asset. What differs is the cash you pay and the tax you save. So the decision is a comparison of net cost after tax, not of the headline price or rental.

If you own the asset, you pay the cost now. Depreciation is then deducted in computing business income. Under section 33 of the Income-tax Act, 2025, depreciation on a block of assets is a prescribed percentage of its written down value. Depreciation is not a cash outflow. But it cuts taxable income, so it saves tax. That saving is the depreciation tax shield: depreciation × tax rate.

If you lease the asset, you pay a rental each year. The rental is a business expense and reduces taxable profit. Each rental therefore costs you only: rental × (1 − tax rate). That is the after-tax rental.

The two streams fall at different times, so you compare them in present value terms. The usual discount rate is the after-tax cost of borrowing: interest rate × (1 − tax rate). The reason is that leasing is a substitute for debt finance. Owning is evaluated as if the purchase is funded by that debt.

The option with the lower present value of net outflow wins. In exam questions, the facts that change the answer are the depreciation rate, whether the asset is a new plant used in manufacture, when it was put to use in the year, the salvage value, and the timing of rentals.

Key rules to remember

Depreciation on block of assets
Depreciation = prescribed rate × written down value of the block
Section 33(3)(a). Use the rate given in the question. WDV falls each year by the depreciation claimed.
Half-rate rule
Depreciation = 50% of the prescribed rate
Section 33(4). Applies if the asset is acquired in the tax year and used for less than 180 days in that year.
Additional depreciation on new plant
20% of actual cost in the year of use; 10% if used for less than 180 days, with 10% more in the next year
Section 33(8) and (9). It needs a manufacturer or power business (generation, transmission or distribution) that acquires and installs new machinery or plant and first puts it to use for business. It is not allowed on plant used by anyone else before, plant installed in office premises or residential accommodation (including a guest house), office appliances, road transport vehicles, or an asset whose whole actual cost is deducted in computing business income.
Depreciation tax shield
Tax shield = depreciation × tax rate
Depreciation is non-cash. The saving is the tax avoided.
After-tax lease rental
After-tax rental = lease rental × (1 − tax rate)
Lease rentals are a deductible business expense. Assumes the lessee has enough profit to absorb the deduction.
Discount rate
After-tax cost of debt = interest rate × (1 − tax rate)
Use it unless the question gives another rate.
Net present cost of owning
NPC (own) = cost − PV of depreciation tax shields − PV of after-tax salvage proceeds
If the asset is bought on a loan and the discount rate is already after-tax, do not also deduct the interest separately.
Net present cost of leasing
NPC (lease) = PV of after-tax lease rentals
Choose the option with the lower NPC.

How to solve Own or Lease Decision questions

Use this order for any own or lease question. Compute both options as costs, then compare.

  1. 1Note the tax rate, discount rate, asset cost, life, salvage value, depreciation rate and lease rental. Note when each cash flow falls.
  2. 2Fix the discount rate. If it is not given, use interest rate × (1 − tax rate).
  3. 3Own option: build the depreciation schedule on WDV at the stated rate. Apply the half-rate rule or additional depreciation only if the facts call for it.
  4. 4Multiply each year's depreciation by the tax rate to get the tax shield. Add any tax effect of the final sale or salvage.
  5. 5Discount the tax shields and salvage. Net cost of owning = cost − PV of shields − PV of salvage.
  6. 6Lease option: compute after-tax rental = rental × (1 − tax rate) each year. Discount them to get the net cost of leasing.
  7. 7Compare the two present values. Pick the lower cost. State the saving and the assumptions you made.
  8. 8Add a one-line conclusion in words, as the paper expects provision, analysis and conclusion.

Quickest way: Two-column present cost comparison

When to use it: Use when the question gives a flat rental and a standard depreciation rate, and asks only which option is better.

  1. Draw two columns: Own and Lease, with a row for each year.
  2. In Own, write depreciation × tax rate for each year. In Lease, write rental × (1 − tax rate).
  3. Multiply both by the same discount factors and total them.
  4. Own cost = purchase price − total PV of shields. Lease cost = total PV of after-tax rentals.
  5. If rentals are level, find the annuity factor once and multiply. Pick the smaller figure.

Common mistakes in Own or Lease Decision

  • Discounting at the pre-tax interest rate.

    Students copy the loan rate from the question without adjusting for tax.

    Fix: Use interest × (1 − tax rate) unless the question gives a discount rate. Cash flows are after tax, so the rate must be too.

  • Ignoring the depreciation tax shield and comparing the cost with pre-tax rentals.

    Depreciation is non-cash, so students leave it out.

    Fix: Depreciation is not a cash flow, but it saves tax. Always compute depreciation × tax rate and deduct it from the cost of owning.

  • Taking the full lease rental as the cost of leasing.

    Students forget that rentals are deductible.

    Fix: Multiply each rental by (1 − tax rate). The tax saved on the rental is a benefit.

  • Charging straight-line depreciation when the question gives a block rate.

    Habit from financial accounting.

    Fix: Under section 33(3)(a), depreciation is a percentage of the WDV of the block. Reduce WDV each year and apply the rate to the lower balance.

  • Counting loan interest as a separate outflow while also discounting at the after-tax cost of debt.

    Students want to show the loan servicing.

    Fix: The discount rate already covers the financing cost. Counting interest again is double counting.

  • Missing the half-rate rule or the additional depreciation conditions.

    Students skip the date of use in the question.

    Fix: Check if the asset was put to use for less than 180 days in the year of purchase (half rate, section 33(4)). Check also whether the buyer is a manufacturer buying new plant (section 33(8)).

Worked examples

Example 1

Alpha Manufacturing Ltd needs a machine costing ₹10,00,000. It can buy the machine or lease it for 3 years at ₹3,60,000 a year, payable at the end of each year. Tax rate is 30%. Depreciation is 40% on WDV. Assume the machine is bought at the start of the year and used for the full year. Ignore additional depreciation, salvage value and tax effects after year 3. This means the WDV left after year 3 is ignored by assumption. Discount rate is 10% after tax. Discount factors: year 1 0.909, year 2 0.826, year 3 0.751. Should the company own or lease?

Show the solution
  1. Depreciation: year 1 = 40% × 10,00,000 = ₹4,00,000. WDV = 6,00,000. Year 2 = 40% × 6,00,000 = ₹2,40,000. WDV = 3,60,000. Year 3 = 40% × 3,60,000 = ₹1,44,000. WDV after year 3 = ₹2,16,000.
  2. Assumption: the remaining WDV of ₹2,16,000 is ignored. No salvage proceeds and no tax shield on it after year 3 are counted. This makes owning look somewhat costlier than it would be if the asset's later benefits were included.
  3. Tax shield at 30%: year 1 = ₹1,20,000; year 2 = ₹72,000; year 3 = ₹43,200.
  4. PV of shields: 1,20,000 × 0.909 = ₹1,09,080. 72,000 × 0.826 = ₹59,472. 43,200 × 0.751 = ₹32,443 (32,443.2). Total = ₹2,00,995 (2,00,995.2).
  5. Net cost of owning = 10,00,000 − 2,00,995 = ₹7,99,005.
  6. After-tax rental = 3,60,000 × (1 − 0.30) = ₹2,52,000 a year.
  7. Annuity factor for 3 years = 0.909 + 0.826 + 0.751 = 2.486. PV of rentals = 2,52,000 × 2.486 = ₹6,26,472.
  8. Compare: leasing costs ₹6,26,472 against ₹7,99,005 for owning. Leasing is cheaper by about ₹1,72,533, on the stated assumption that the remaining WDV is ignored.

Answer: Lease the machine. Its net present cost is ₹6,26,472 against ₹7,99,005 for buying, a saving of about ₹1,72,533. This holds on the assumption that the ₹2,16,000 WDV left after year 3 is ignored.

Example 2

Using the data in the previous example, find the highest annual lease rental (payable at the end of each year) at which Alpha Manufacturing Ltd would be indifferent between owning and leasing. Keep the same assumption that the WDV of ₹2,16,000 left after year 3, and any salvage value, is ignored.

Show the solution
  1. At indifference, net cost of leasing = net cost of owning = ₹7,99,005 (approximately; exact figure 7,99,004.8). This cost of owning ignores the ₹2,16,000 WDV left after year 3.
  2. Let the annual rental be R. After-tax rental = R × (1 − 0.30) = 0.7R.
  3. PV of after-tax rentals = 0.7R × 2.486 = 1.7402R.
  4. Set 1.7402R = 7,99,004.8.
  5. R = 7,99,004.8 ÷ 1.7402 ≈ ₹4,59,145.
  6. Check: 4,59,145 × 1.7402 ≈ ₹7,99,004, which matches the cost of owning.
  7. Note: if you counted the later tax shield or salvage on the remaining WDV, owning would cost less and the break-even rental would be lower than ₹4,59,145.

Answer: The break-even rental is about ₹4,59,145 a year, valid only under the assumption that the WDV left after year 3 is ignored. Any rental below this makes leasing cheaper on that basis. The rental of ₹3,60,000 in the first example is well below it.

Exam tips

  • Write the assumptions first: tax rate, discount rate, timing of cash flows, and that the lessee has enough profit to use the deductions. Markers give credit for stated assumptions.
  • Show the depreciation schedule in a small table. Even if the final answer is wrong, the working earns marks.
  • Use the rate given in the question for depreciation. Do not quote a rate from memory. Cite section 33 for the basis of block WDV depreciation, half rate and additional depreciation.
  • Read dates of purchase and use carefully. A purchase in the last months of the year can trigger the half-rate rule under section 33(4).
  • End with a clear recommendation in one or two sentences and mention any non-tax factors briefly, such as obsolescence or maintenance.

Practice questions from Tax Planning and Managerial Decisions

Own or Lease Decision in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Own or Lease Decision: frequently asked questions

Why is the after-tax cost of borrowing used as the discount rate?

Leasing is a substitute for borrowing to buy the asset. The cash flows being compared are after tax. So the rate used to discount them should be the after-tax cost of debt, that is, interest × (1 − tax rate).

Is depreciation a cash flow in the own or lease decision?

No, depreciation is not a cash outflow. It matters only because it reduces taxable income. The cash benefit is the tax saved, which is depreciation × tax rate.

How is the lease rental treated for tax?

The lessee treats the rental as a business expense. So each rental costs the lessee only the rental × (1 − tax rate), provided the lessee has enough profit against which to claim it.

Does additional depreciation apply in every own or lease question?

No. Section 33(8) allows it only when a manufacturer or power business acquires and installs new machinery or plant and first puts it to use for business. It is not allowed on plant used by anyone before, plant in office premises or residential accommodation, office appliances, road transport vehicles, or assets whose whole cost is deducted. Under section 33(9), if the plant is used for less than 180 days, 10% is allowed in that year and 10% in the next. Check the facts before adding it.

What if the tax rate or profit is too low to use the deductions?

Section 33(11) deals with this. If profits before depreciation are positive but less than the deduction, depreciation is allowed to the extent of those profits and the balance is carried forward to the next year. If there is a loss, no depreciation is allowed in that year and the full amount is carried forward. This is subject to sections 112(3) and 113(4). In an exam, state your assumption that profits are enough, unless the question says otherwise.