Buy, HP, or lease?
Contents
The decision to buy, hire purchase, or lease an asset will generally depend on the financing available to your business.
There are different treatments for tax and accounting purposes, depending on the type of finance contract entered into, and these will need to be considered together with the VAT treatment.
Buy
This section covers outright purchase for cash or by bank loan, etc.
Accounting treatment
From an accounting viewpoint the actual cost of the asset is capitalised in the balance sheet and an annual charge for depreciation is shown in the accounts as an expense in the profit and loss account. This therefore has the effect of showing the asset(s) in the balance sheet at cost, reduced by the cumulative charge for depreciation.
The annual depreciation charge is calculated in accordance with accounting standards, based on the useful economic life of the asset and the residual value.
Tax treatment
The actual charge for depreciation is not allowed for tax purposes, as this is replaced by capital allowances, which is HM Revenue & Customs deduction regime for allowing capital expenditure against chargeable profits. The first £100,000 of expenditure each year on plant and equipment, excluding cars, qualifies for a 100 per cent capital allowance deduction. Expenditure in excess of £100,000 enters either the 10 per cent pool or the 20 per cent pool, attracting a writing down allowance (WDA) at the appropriate rate.
Any business that invests in energy-saving or water-efficient technology is entitled to claim a 100 per cent first year allowance. Cars with CO2 emissions of up to 110 g/km also qualify for a 100 per cent first year allowance. Cars with CO2 emissions of up to 110 g/km will also qualify for a 100 per cent first year allowance. Cars with CO2 emissions that are greater than 110 g/km and up to 160 g/km will be allocated to the main pool and attract the 20 per cent writing down allowance. Cars with CO2 emissions exceeding 160 g/km will enter the special rate pool and attract WDA at 10 per cent.
A 100 per cent capital allowance is also available for new or unused (i.e. not second hand) vans that do not produce any CO2 emissions.
The finance charge in the accounts is normally allowed against tax.
VAT
Unless the asset is a car, the VAT shown on the supplier's invoice will generally be recoverable by the purchaser, if he or she is registered. Buying at the beginning of a VAT period will entail a wait of three months or more to recover the tax. VAT on cars is recoverable only in very rare circumstances.
Hire purchase
A HP agreement usually includes an option to purchase at the end of an initial period. Payment of this nominal fee transfers title of the asset and brings the legal agreement to an end.
Accounting treatment
The asset is treated as if it had been purchased. It is, therefore, capitalised in the balance sheet and depreciation is provided on an annual basis.
The obligation to pay future instalments is recorded as a liability in the balance sheet.
The payments are apportioned between a finance charge and a reduction of the outstanding liability.
The total finance charge should be allocated to accounting periods during the HP term and is shown as an expense in the profit and loss account.
Tax treatment
The actual charge for depreciation is not allowed for tax purposes, as this is replaced by capital allowances, which is HM Revenue & Customs deduction regime for allowing capital expenditure against chargeable profits. The first £100,000 of expenditure each year on plant and equipment, excluding cars, qualifies for a 100 per cent capital allowance deduction. Expenditure in excess of £100,000 enters either the 10 per cent pool or the 20 per cent pool, attracting a writing down allowance (WDA) at the appropriate rate.
Any business that invests in energy-saving or water-efficient technology is entitled to claim a 100 per cent first year allowance. Cars with CO2 emissions of up to 110 g/km also qualify for a 100 per cent first year allowance. Cars with CO2 emissions of up to 110 g/km will also qualify for a 100 per cent first year allowance. Cars with CO2 emissions that are greater than 110 g/km and up to 160 g/km will be allocated to the main pool and attract the 20 per cent writing down allowance. Cars with CO2 emissions exceeding 160 g/km will enter the special rate pool and attract WDA at 10 per cent.
A 100 per cent capital allowance is also available for new or unused (i.e. not second hand) vans that do not produce any CO2 emissions.
The finance charge in the accounts is normally allowed against tax.
VAT
VAT charged by the finance company will be payable with the initial installment. There will be a delay of up to four months in recovering this from HM Revenue & Customs. In the case of a car, most businesses will be unable to recover any of the VAT.
Finance leases
A finance lease typically has a primary period for a fixed period at full cost, followed by a secondary period, usually of an indefinite length, at a very low cost.
Accounting treatment
The asset is treated as if it had been purchased. It is therefore capitalised in the balance sheet and depreciation is provided on an annual basis.
The obligation to pay future rentals is recorded as a liability in the balance sheet.
The rents payable are apportioned between a finance charge and a reduction of the outstanding liability.
The total finance charge should be allocated to accounting periods during the primary lease term and is shown as an expense in the profit and loss account.
Tax treatment
Where accounts have been prepared in accordance with accounting standards, the accounting treatment will be acceptable for tax purposes and no adjustments to profit need be made.
Where accounts have not been prepared in accordance with accounting standards, for tax purposes the rentals are deductible in computing profits under the accrual concept. The rentals are, therefore, allocated over the period of the lease.
Where the asset is a car with CO2 emissions exceeding 160 g/km, there is a flat rate disallowance of 15 per cent on the amount of rental payments allowed for tax purposes.
Capital allowances are not available.
VAT
VAT charged by the finance company will be payable with the initial instalment and each subsequent rental. There will be a delay of up to four months in recovering this from HM Revenue & Customs. In the case of a car, most businesses will be able to recover 50 per cent of the VAT.
Operating leases
An operating lease is where an asset is rented for a period, not necessarily fixed, and returned to the owner at the end of the period. Contract hire is a typical form of operating lease.
Accounting treatment
The asset is not capitalised; the rental payments are charged on an acceptable basis over the lease term to the profit and loss account.
Tax treatment
The accounting treatment is an acceptable treatment for tax purposes, where the accounting standard has been applied. No adjustments to profits, therefore, need be made.
Where the asset is a car with CO2 emissions exceeding 160 g/km, there is a flat rate disallowance of 15 per cent on the amount of rental payments allowed for tax purposes.
Capital allowances are not available.
VAT
Each rental or instalment will have VAT added so that the VAT cost is spread throughout the period of the agreement.
Where the asset is a car, only 50 per cent of the VAT on the leasing charges can be reclaimed. If identified separately, the VAT on any maintenance element of the contract can be reclaimed in full.
The disposal proceeds of leased cars will be VAT inclusive.
| Summary | ||||
| Accounting treatment | Tax treatment (deductions normally allowed) |
VAT (normal treatment) |
||
| Buy | Asset Depreciation |
Capital allowances Interest |
Up front | |
| HP | Asset / liability Depreciation Interest |
Capital allowances Interest |
Up front | |
| Finance Lease | Asset / liability Depreciation Interest |
Depreciation Interest |
On each instalment | |
| Operating Lease | Rental expense as you go | Rental | On each instalment | |
Contact Us if you would like any further help or advice in this area.
