Buy, HP or Lease?

Sometimes the decision to either buy, hire purchase (HP) or lease an asset isn't straight forward.

There are different treatments for tax and accounting purposes depending on the type of finance contract agreed.

Before you agree to sign any legal document it's useful to know the consequences:

Buying

If you purchase with cash or by bank loan:

  • Accounting treatment: 

The asset is included on the balance sheet and an annual charge for depreciation is deducted as an expense in the profit and loss account, which in turn reduces the value of the asset in the balance
sheet.

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 depreciation mentioned above is not allowed for tax purposes, but capital allowances may be available instead.

The maximum amount of the annual investment allowance (AIA) is £200,000.

Qualifying expenditure on plant and machinery (not cars) up to the maximum AIA amount attracts 100% relief.  Annual expenditure over that amount attracts an annual writing down allowance of either 8% or 18% depending on the nature of the asset.

Hire purchase (also known as Lease purchase)

An 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, included 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.

Monthly payments are apportioned between a finance charge and a reduction of the outstanding liability.

Finance charges are shown as an expense in the profit and loss account.


  • Tax treatment

Capital allowances are available for qualifying assets which are in use at the end of the accounting period. 

The finance charge in the accounts is normally allowed against tax.

Finance leases

A finance lease 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.

Short Leases

 - Accounting treatment

For some finance leases of up to seven years, the accounting treatment follows the strict legal position. Ownership remains with the lessor, and the rental payments are shown as expenses in the lessee’s profit and loss account.

- Tax Treatment

The lessor (as owner) is entitled to the capital allowances, and the rental payments are generally allowable in calculating in the lessee’s profit.  If the asset is a car with CO2 emissions exceeding 110g/km, there is a flat rate disallowance of 15% on the amount of rental payments allowed for tax purposes.


Long term Leases

- Accounting treatment

The asset is included 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.

Rents payable are apportioned between a finance charge and a reduction of the outstanding liability. 

Finance charges are allocated to accounting periods during the primary lease term and shown as an expense in the profit and loss account.

- Tax treatment

The tax treatment is aligned with the accounting treatment, and the lessee  can claim capital allowances on qualifying assets.


- VAT on finance leases

VAT charged by the finance company will be payable with the initial instalment and each subsequent rental. 

Operating leases

An operating lease is where an asset is rented for a period 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 accounting standards have been applied. 

Where the asset is a car with CO2 emissions exceeding 130 g/km, there is a flat rate disallowance of 15% 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% 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.

Next steps

If you are unsure which is the best option for your business please ask us before signing any agreements.

 

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