Local accountants and tax advisers, Trueman Brown, advise businesses that there is no definitive answer to whether you should hire or purchase that big, shiny new plant.
A common scenario for us is that a client will contact, with a pertinent question to their business – we need to purchase a new asset, such as an expensive van, so what would be the most tax efficient means of purchasing that asset?
The correct answer is that the mode of purchase should be dictated by the business cash flow status at that particular point in time.
However, there are a various tax advantages that each mode has which should always enter the decision-making process.
VARIOUS METHODS
There are four ways that a business could obtain an asset:-
- Outright purchase;
- Hire purchase;
- Finance Lease
- Operating Lease.
Outright Purchase
The business would purchase the business outright. Obviously, this could mean a large financial commitment is undertaken at the point of purchase.
The accounting and tax effects are as follows: –
| Accounting Treatment | The item purchased is capitalised and shown as an asset in the business balance sheet and is depreciated over the useful economic life of the assets. Depreciation is written off against reported profit. |
| VAT Treatment | VAT on the purchase of the asset can be claimed unless it is a motor vehicle. VAT cannot be reclaimed on the purchase of the motor vehicle unless it is used exclusively (100%) for business purposes or if the car is used mainly as a taxi or a car for a driving school. |
| Tax Treatment | Depreciation charge is not an allowable charge. Replaced by capital allowances. Any finance charges associated with the purchase is normally allowed against tax. |
Hire Purchase
An HP agreement is a lease agreement with an option to purchase the asset at the end of the initial lease period.
The accounting and tax effects are as follows:-
|
Accounting Treatment |
The item purchased is capitalised and shown as an asset in the business balance sheet and is depreciated over the useful economic life of the assets. Depreciation is written off against reported profit. The obligation to pay regular payments is recorded as a liability in the balance sheet. The regular payments are split between the finance charge and the outstanding liability. Finance charge allocated to the profit and loss account, as an expense, over the life of the agreement. |
|
VAT Treatment |
VAT on the purchase of the asset can be claimed, on the initial instalment, unless it is a motor vehicle. VAT cannot be reclaimed on the purchase of the motor vehicle unless it is used exclusively (100%) for business purposes or if the car is used mainly as a taxi or a car for a driving school. |
|
Tax Treatment |
Same as outright purchase |
Finance Lease
A finance lease is where a business will rent an asset for a fixed term AND “substantially all of the risks and rewards of ownership of the asset” has been transferred to the lessee.
For example, the lessee will be expected to insure the vehicle and to be responsible for the upkeep and maintenance of the asset.
The accounting and tax effects are as follows:-
|
Accounting Treatment |
The item is capitalised and shown as an asset in the business balance sheet and is depreciated over the useful economic life of the assets. Depreciation is written off against reported profit. The rents payable are recorded as a liability in the balance sheet. The rents paid are split between the finance charge and the outstanding liability. Finance charge allocated to the profit and loss account, as an expense, over the life of the agreement. |
|
VAT Treatment |
VAT charged can be claimed on the initial rental and all subsequent rentals. With respect to a car, the business can claim 100% of the VAT if it used exclusively for the business or 50% on the finance element of the rentals if the vehicle is used privately. |
|
Tax Treatment |
No capital allowances claim can be made. Rentals are deductible in computing taxable profits under the accruals concept. If the asset is a car with CO2 emissions exceeding 130g/km, 15% of the rental amount is disallowed. |
Operating Lease
A finance lease is where a business will rent an asset for a fixed term AND “substantially all of the risks and rewards of ownership of the asset” have NOT been transferred to the lessee.
The accounting and tax effects are as follows:-
| Accounting Treatment | The asset is NOT capitalised. The rents paid are charged to the profit and loss account over the life of the lease. |
| VAT Treatment | VAT charged can be claimed on the initial rental and all subsequent rentals. With respect to a car, the business can claim 100% of the VAT if it used exclusively for the business or 50% on the finance element of the rentals if the vehicle is used privately. |
| Tax Treatment | No capital allowances claim can be made. Rentals are deductible in computing taxable profits under the accruals concept. If the asset is a car with CO2 emissions exceeding 130g/km, 15% of the rental amount is disallowed. |
Local accountants and tax advisers, Trueman Brown, deliver vital services to small business. Please contact us if you require assistance.