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To Buy Or Not To Buy

14 June 2012

This is indeed the question on most people’s minds as they consider how best to finance the purchase of that new business vehicle.  There are various options – buy (either cash, bank loan or hire purchase), finance lease or operating lease.  The commercial, accounting and tax implications of each option vary significantly and finding the most advantageous method for your business can be tricky.

Example

The effect of the different tax treatments can often mean that the tax consequences of the acquisition vary.  This is best illustrated by way of an example: 

 

Cash
acquisition 

Hire Purchase
or loan 

Finance
Lease 

Operating
Lease 

 





 

£

£

£

£

Capital outlay (including irrecoverable VAT)

20,000

20,000

15,000

 -

Potential proceeds of sale after 3 years

(7,500)

(7,500)

 -

 -

Total capital cost

12,500

12,500

15,000

 -

Rental payments (including irrecoverable VAT)

 -

 -

 -

12,000

Total interest costs (@ 8% APR)

 -

2,480

1,860

 -

Fuel cost

6,000

6,000

6,000

6,000

Insurance

1,750

1,750

1,750

1,750

Service, maintenance and breakdown cover

1,350

1,350

1,350

1,350

Total profit and loss expenses

9,100

11,580

10,960

21,100

Deductible depreciation (@ 33.33% SL)

 -

 -

15,000

 -

Capital allowances

12,500

12,500

 -

 -

Total tax deductions

21,600

24,080

25,960

21,100

Tax saving thereon (@20%)

(4,320)

(4,816)

(5,192)

(4,220)

VAT reclaimable

 -

 -

(1,364)

(1,091)

Total cash outlay

17,280

19,264

19,404

15,789

(Based on an Audi A3 1.6 TDI S Line 105PS (diesel) costing £20k, CO2 111g/km, costs over 3 years, assuming 20,000 miles per annum)

The above example suggests that in this instance an operating lease or outright ownership would be best, with a finance lease being the least attractive option.  However, this might not always be the case.  The results can vary depending on the make and model of the car and the rates and offers available from the finance companies at the time.  The recoverability of the VAT, the restrictions on tax relief for cars with high CO2 emissions and the effects of personal use can also change the results.

Main differences

Whilst hire purchase and finance lease contracts are fairly common for cars, operating leases can be more difficult to source.  Operating leases are more normally used for specialised and higher value assets, such as HGVs, machinery and IT equipment.

 

Legal title

 

  • When buying an asset legal title of the vehicle passes to you on acquisition (or at the end of the hire purchase agreement). 
  • When leasing an asset legal title of the vehicle remains with the leasing company.

Lease term/cost

 

  • Operating leases usually have shorter terms and often you pay less than the full cost of the vehicle.
  • Loans, hire purchase agreements and finance leases have additional finance costs, such as interest and arrangement fees, which cash purchases might not.

Accounting Treatment

 

  • When buying or finance leasing a vehicle the asset is capitalised in the accounts as a fixed asset and the cost is then released to the profit and loss account (depreciated) over the expected useful life of the vehicle.
  • With an operating lease, the rent payments are taken directly to the profit and loss account in the year in which they arise.

Tax Treatment

 

  • When buying, the accounts depreciation charge is a non deductible expense when calculating taxable business profits.  However, capital allowances can be claimed on the fixed asset costs.
  • Finance leases do not attract capital allowances.  However the depreciation charge in the accounts (if at a commercial rate) may be tax deductible.
  • Operating lease rental costs are tax deductible in the year they are incurred.
  • Tax relief for car finance and operating leases can be restricted if the car has high carbon dioxide emissions.

VAT Treatment

 

  • If a car is bought (including hire purchase) the input VAT may be fully recoverable if the vehicle is used solely for business purposes.  However, this can be difficult to prove to HMRC and it’s more likely that the input VAT will not be recoverable. 
  • For finance and operating leases, only 50% of the input VAT on the rental costs is recoverable on cars.
  • 100% is recoverable on vans regardless of private use or method of acquisition.

 

Some other considerations

Private Use

The above example assumes that the car is used solely for business purposes.  If the car was available for private use, the tax relief available for the costs would be restricted for owners of unincorporated businesses.  Benefit in kind taxes would also arise for employees or for owners/directors of companies.  The effect of this could change the most efficient method of acquisition.

Car or van

If the vehicle is to be made available to employees for private use it might be worth considering purchasing/leasing vans rather than cars as they often attract lower benefit in kind taxes.  However, ‘green cars’ (with low carbon dioxide emissions) can still be tax efficient.

Business or personal ownership

Vehicles owned by a business can give rise to hefty benefit in kind charges or substantial restrictions on tax relief if used for both business and personal journeys.  It might therefore be worth considering keeping the vehicles out of the business and instead claiming a ‘mileage allowance’ for business mileage undertaken in a personally owned vehicle.

The answer to the question “should I buy or lease” is by no means straightforward and it is advisable therefore to seek tax advice before making any decision to buy or lease high value assets.

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