Vehicle in an Operating Lease Agreement – How to Reflect It in Accounting?

When a company enters into an operating lease agreement for a vehicle, it is recorded in the accounting as a lease, not as a fixed asset. Under an operating lease, the vehicle remains the property of the lessor, and the company pays rental fees for its use over a specified period. At the end of the lease term, the vehicle may be returned to the lessor or purchased, depending on the agreement.

Can a company record such a leased asset as a fixed asset during the lease period?
How should VAT and other expenses related to operating lease transactions be accounted for?

Accounting for Operating Lease

According to Cabinet Regulation No. 775 “Regulations for the Application of the Annual Financial Statements and Consolidated Financial Statements Law”, section 231, the classification of a lease as financial or operating depends on the substance and nature of the lease transaction, not merely its legal form.

In the case of an operating lease:

The vehicle is not recorded in the company’s balance sheet as a fixed asset;
Lease payments are recognized as expenses during the periods in which they are incurred;
Input VAT is deductible in accordance with invoices issued by the lessor.

VAT Accounting in Operating Lease Transactions

According to Section 92(1)(1) of the Value Added Tax Law, taxable persons may deduct input VAT on lease payments and related costs, provided the vehicle is used for taxable transactions. However, Section 100 of the VAT Law sets specific restrictions on input VAT deductions, especially for passenger vehicles.

Key Criteria for Operating Lease Classification

As per section 233 of the regulation, a lease is classified as an operating lease if at least one of the following conditions is met:

The lease term is relatively short compared to the useful economic life of the vehicle;
The lease does not anticipate the transfer of ownership at the end of the lease term;
The risks and rewards associated with the vehicle remain with the lessor.

Conclusion

Companies using vehicles under operating lease agreements must ensure the correct classification of the lease in order to comply with regulatory requirements. Accounting treatment must reflect the economic substance of the transaction, not just the legal form, to avoid potential tax adjustments or penalties.