Finance structured to suit your business, from Operating Leases and Finance Leases to Energy Service Agreements, PPAs and Storage as a Service.
Financing of energy efficiency projects allows the cost outlay to be matched with the projected savings.
Historically the main types of asset finance have been Hire Purchase, Finance Lease and Operating Lease.
More recently the ‘Energy Services Agreement’ (ESA) has developed in the US. Under international accounting standards, it effectively allows energy efficiency measures to be financed ‘off-balance sheet’.
The business pays for whatever asset it is buying (in this case solar PV, battery, LED lighting etc) in instalments and then takes ownership of the asset at the end of the fixed term of the financing.
VAT is payable on the purchase price. Writing down allowances can be claimed and the repayment interest is treated as a revenue deduction.
A finance lease is a way of providing finance – effectively a leasing company (the lessor or owner) buys the asset for the user (usually called the hirer or lessee) and rents it to them for an agreed period.
A finance lease is defined in Statement of Standard Accounting Practice 21 as a lease that transfers “substantially all of the risks and rewards of ownership of the asset to the lessee”.
The lessee is in a broadly similar position as if they had bought the asset.
The lessor charges a rent as their reward for hiring the asset to the lessee. The lessor retains ownership of the asset but the lessee gets exclusive use of the asset (providing it observes the terms of the lease).
Note that writing down allowances are not available. Instead, lease payments (comprising capital and interest) are treated as a revenue deduction. VAT is payable on the rental payments, not the purchase price.
The lessee will make rental payments that cover the original cost of the asset, during the initial, or primary, period of the lease. So the present value of the payment stream equals the acquisition cost of the asset. Once all payments have been made, the lessor will have recovered its investment in the asset.
At the end of the lease
What happens at the end of the primary finance lease period will vary and depends on the actual agreement but the following are possible options:
An Operating lease is a contract wherein the owner, called the lessor, permits the user, called the lessee, the use of an asset for a particular period without any transfer of ownership rights. It will generally run for less than the full economic life of the asset and the lessor would expect the asset to have a resale value at the end of the lease period – known as the residual value.
Writing down allowances are not available. Lease payments are treated as an expense as they are paid over the life of the lease contract. VAT is payable on the rental payments, not the purchase price.
An operating lease does not transfer substantially all of the risks and rewards of ownership to the lessee. This residual value is forecast at the start of the lease and the lessor takes the risk that the asset will achieve this residual value or not when the contract comes to an end. It is typically used when the assets do have a residual value e.g. vehicles, construction plant and machinery. The customer gets the use of the asset over the agreed contract period in return for rental payments. These payments do not cover the full cost of the asset as is the case in a finance lease.
Operating leases sometimes include other services built into the agreement, e.g. a maintenance agreement.
Ownership of the asset remains with the lessor and the asset will either be returned at the end of the lease, when the leasing company will either re-hire in another contract or sell it to release the residual value. Or the lessee can continue to rent the asset at a fair market rent which would be agreed at the time.
On 1st January 2019, the accounting standard IFRS 16 Leases came into effect. Lessees need to account for their leases under a single accounting treatment, generally bringing all leases ‘on balance sheet’. The ESA offers a way to access energy efficiency measures ‘off-balance sheet’.
The Energy Services Agreement (ESA) is a relatively new and exciting financial vehicle for funding energy efficiency. Similar to the Solar Power Purchase Agreement (PPA), under an ESA, the equipment is installed, owned and operated by the vendor / financier (an Energy Services Company, or ESCO). The ESCO sells the saved power to the customer, typically via monthly payments over an agreed operational period of 5 years or so.
ESAs offer a clearly defined structure for outside capital to invest in the energy savings potential of a site. The ESA provider is effectively paid for the energy savings of a retrofit project.
ESAs have two defining features:
The equipment installed is energy efficiency equipment – anything from insulation, double glazing to solar PV, battery storage, LED lighting, upgraded heating systems.
The site owner typically pays for savings on a kWh basis. They end up with two power bills… one for the balance of power required from the mains electricity / gas / water supplier, and one from the ESA vendor for power saved, that would otherwise have had to have been purchased. As long as their combined bill is less than what would have had to have been paid to the mains supplier had the energy efficiency measures not been carried out, the site owner wins.
The benefits of the ESA are as follows: