The decision to buy, hire purchase or lease an asset will usually depend on how much financing the business has available to it.

These various methods are treated in different ways for tax, accounting and VAT purposes. Each method will be discussed below to aid you in making the correct decision.

Buy

This is where you purchase the asset outright for cash.

Accounts Treatment

In the accounts the asset will be capitalised at its actual cost in the balance sheet and then depreciated.

The depreciation will be an expense in the profit and loss account each year.

Depreciation will be calculated in accordance with accounting standards, being based on the estimated useful life of the asset and the estimated residual value of the asset when you decide to sell it.

Tax Treatment

The depreciation charged in the accounts is not an allowable expense for tax purposes and must be added back. Instead, capital allowances can be deducted from chargeable profits. From April 2008 the first £50,000 of capital expenditure on plant and machinery, excluding cars, qualifies for 100% capital allowances. Hence, the total cost of the asset can be deducted from accounting profits. Any expenditure above this £50,000 limit will qualify for a written down allowance of 10% or 20%.

Click here for further information on capital allowances.

VAT Treatment

Generally, the VAT provided on the supplier invoice for the asset can be claimed back, assuming the asset is not a car. Only in rare circumstances can the VAT be reclaimed on the purchase of a car.

Hire Purchase

An HP agreement will usually give the purchaser an option to purchase fee at the end of the contract. This nominal fee is usually paid along with the final repayment and transfers the legal title of the asset to the purchaser. You do not own the asset until this final payment has been made to the finance company.

Accounts Treatment

The asset is treated as though it has been purchased, and hence is capitalised in the balance sheet at cost and depreciated annually.

A liability is set-up in the balance sheet to denote the obligations due to the finance providers. This liability is reduced as each repayment is made.

The repayments are apportioned between the capital repayment element and finance charges. The finance charges are allowed as an expense in the profit and loss, while the capital element reduces the outstanding liability in the balance sheet.

Tax Treatment

The depreciation charged in the accounts is not an allowable expense for tax purposes and must be added back. Instead, capital allowances can be deducted from chargeable profits. From April 2008 the first £50,000 of capital expenditure on plant and machinery, excluding cars, qualifies for 100% capital allowances. Hence, the total cost of the asset can be deducted from accounting profits. Any expenditure above this £50,000 limit will qualify for a written down allowance of 10% or 20%.

Click here for further information on capital allowances.

The finance charges in the accounts are usually allowed for tax purposes.

VAT Treatment

The VAT is normally paid within the initial deposit and therefore can be claimed back on the next VAT return, assuming the asset is not a car. Only in rare circumstances can the VAT be reclaimed on a car.

Finance Leases

A finance lease typically has a primary fixed period at full cost, followed by a secondary period at very low cost which can last indefinitely.

Accounts Treatment

The asset is treated as though it has been purchased, and hence is capitalised in the balance sheet at cost and depreciated annually.

A liability is set-up in the balance sheet to denote the obligations to make future rentals.

The rent payments are apportioned between the reduction in outstanding liability and finance charges.

The total finance charges should be apportioned over the primary fixed term of the lease and shown as an expense in the profit and loss account.

Tax Treatment

No adjustments to profit will need to be made where the accounts have been prepared in accordance with accounting standards. However, where this is not the case, the rentals are deductible in computing profits. The rentals are allocated over the period of the lease.

Please note that capital allowances are not available.

For cars costing more than £12,000, the rentals must be restricted.

VAT Treatment

VAT will be payable with the first instalment and all future instalments. This can be claimed back each VAT quarter.

Generally, only 50% of the VAT can be claimed back on car rental payments.

Operating Leases

An operating lease typically involves an asset being rented for a period and then returned to the owner at the end of this period.

Accounts Treatment

The asset is not capitalised in the balance sheet.

The rentals payments are charged over the lease term on a reasonable basis to the profit and loss.

Tax Treatment

The accounting treatment is acceptable for tax purposes, provided the accounting standards have been applied.

Please note that capital allowances are not available.

For cars costing more than £12,000, the rentals must be restricted.

VAT Treatment

Each rental will be inclusive of VAT, and can be reclaimed each quarter.

For cars, only 50% of the VAT can be reclaimed

The disposal proceeds of a leased vehicle will include VAT.

Summary Table
		Buy		HP		Finance Lease		Operating Lease
Accounts Treatment		Capitalise Asset		Capitalise Asset/Liability		Capitalise Asset/Liability		Rental Expense
		Depreciation		Depreciation and Interest		Depreciation and Interest
Tax Treatment		Capital Allowances		Capital Allowances		Depreciation		As Per Accounts
		Interest Expense		Interest Expense		Interest
VAT Treatment		Paid Up Front		Paid Up Front		Each Instalment		Each Instalment

 

Please contact us for further information.