Hire purchase vs contract hire: the tax implications

Whichever option you plump for, there are tax implications to consider. Here’s what fleet managers need to know.

There are several tax implications to consider, including capital allowances, corporation tax, VAT and Class 1A National Insurance Contributions, says Gerry Keaney, chief executive of the British Vehicle Rental and Leasing Association (BVRLA).


He explains: “Companies can claim corporation tax and VAT relief on the costs they incur, including ancillary costs such as maintenance and fuel, while corporation tax is linked to a car’s CO2 emissions and the way in which the car is acquired and financed.”

The straightforward solution

From a tax perspective, many fleet operators may see the simplest option is contract hire, where 100% of the monthly rental cost can be offset against profits. VAT relief is also available, depending on how the vehicle is used. For example, a company that uses contract hire to finance a car can recover 100% of the VAT of the monthly rentals if the vehicle is only used for business. If there is any private use, 50% of the VAT can be recovered.


With a hire-purchase agreement, the monthly payments cannot be offset against tax, only the interest element within each payment. And unless they can prove that the car is for business use only, companies cannot normally recover VAT on the purchase of a new car. However, the vehicle will qualify for capital allowances, where, at the end of the accounting year, a percentage of the vehicle value can be used to reduce taxable profits.


The capital allowance that can be claimed is based on the car’s CO2 emissions. Cars with emissions over 130g/km go into the special rate pool (8%), while cars with emissions below 130g/km go into the main rate pool (18%). As announced in the March 2016 Budget, from April 2018 the main-rate threshold for capital allowances for business cars falls from 130g/km to 110g/km. Businesses can claim 100% first-year allowances on low-emission cars and new zero-emission goods vehicles purchased for business use.

Government influence

Ian Hill, managing director at Activa Contracts, says: “The government is raising more money through vehicle taxation and trying to influence the behaviour of both companies and their employees in their company-car operating decisions, notably towards increasing the uptake of plug-in and ultra-low emission models.”


Depreciation is another factor to consider in comparing the two asset finance options. “With contract hire, the company is effectively only paying for the difference between what the vehicle initially cost and its value at the end of the hire period,” says Lauren Pamma, head of consultancy at Lex Autolease. “With a hire-purchase agreement, the company pays for depreciation from its purchase to disposal.”


A company car that is made available to an employee for their private use can qualify for benefit-in-kind taxation. However, as Pamma explains: “There won’t be any difference in benefit-in-kind whether the company has financed the vehicle through hire purchase or contract hire. Whatever the rules are, they would apply to either finance option.”


Clearly there is no one-size-fits-all finance solution, and for more complex fleets a combination of funding solutions, which could include hire purchase, lease purchase, contract purchase, finance lease and operating lease, could be the best option.


“Contract hire is typically the lowest-cost solution for ‘normal’ businesses with mainstream corporate tax and VAT positions, that are cash-flow conscious, averse to risk and have limited fleet-management expertise,” says Geoffrey Bray, chairman of the Fleet Industry Advisory Group (FIAG). “However, outright purchase of vehicles could be applicable for organisations that cannot, or can only partially, recover VAT, qualify for zero or minimal corporation tax relief, and that are not averse to risk or are cash rich.”

Greater flexibility

Contract hire also enables a company to be more flexible, which can prove extremely useful as the government can and often does change the regulatory environment.


Gerry Keaney says: “Minor tax tweaks can easily impact a vehicle’s total cost of ownership, so the most efficient cars on the fleet in 2017 may not be the cheapest options in 2018. For example, as of 1 April 2017, there has been a shift in the vehicle excise duty (VED) structure that moves the standard rate away from being CO2 based to a flat rate of £140. Cars costing above £40,000 now pay an additional supplement of £310 on the basic rate. This is a consideration for SMEs who buy their cars outright.”


Companies are well advised to undertake an annual root-and-branch review of their fleet funding strategy; more frequently if corporate or legislative circumstances change, as John Pryor, chairman of the Association of Car Fleet Operators (ACFO), explains.


“Legislation is changing continually,” he says. “For example, company car benefit-in-kind tax rates tighten annually over the coming years, capital allowance thresholds will change in April 2018, and a new lease-accounting standard becomes mandatory from 1 January 2019. All will impact to a greater or lesser extent on fleet funding, and ultimately, on whether current strategies should change.


“Best practice would dictate that vehicles are selected using a whole-life cost or total-cost-of-ownership model, which would take account of all funding expenditure and the ability to limit tax exposure.


“Whether from ACFO, trade publications, leasing companies, training organisations such as the Institute of Car Fleet Management [ICFM], accountants or other sources, there is a wealth of expert advice available, but ultimately every fleet and business is different and the chosen funding channel must fit their own corporate and vehicle operating profile.”

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