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How finance lease can help beat the VAT increase

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Finance lease: is it for you?

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17 December 2010

Businessman considering finance lease
Finance lease: is it for you?

IN January VAT goes up. How can you find a cost-effective funding method for business cars to help you minimise the cost of the VAT rise? Ralph Morton files this special report on finance lease for company cars.

 

IT’S hard not to ignore the forthcoming VAT rise on 04 January 2011.

One way or another it’s going to impact on your business.

The Federation of Small Businesses (FSB) believes small firms will be hit hard by the 2.5% rise in VAT. The FSB believes that, unlike bigger businesses, they can’t absorb the increase.

This will mean that small firms will have to pass the full cost on to customers, reduce stock levels or find cost savings elsewhere – potentially costing jobs and undermining the government’s private sector led recovery. For business car managers, the cost of car acquisition will rise, particularly for those SMEs that still like to buy their own business cars.

For example, Audi’s new A7 Sportback – the company’s new executive hatchback – will see a price rise from £42,925 pre-VAT increase to £43,745 post VAT rise.

So do you just take the additional VAT on the chin? One way to make your car acquisition VAT effective is to consider finance lease.

Finance lease is a good halfway house between owning your company car and outright business car usership known as contract hire.

Finance lease has all the benefits of ownership, but many of the cash flow and VAT advantages of contract hire.

VAT advantages of finance lease

VAT is charged on the rentals of a finance lease. Assuming there will be some private use of the company car, 50% of the VAT can be reclaimed.

There is a further advantage to finance lease. The finance company providing the car can reclaim the full 100% of the VAT on the purchase of the vehicle; it can then pass on this VAT saving in the form of lower rentals to you.

Cash flow advantages of finance lease

There are two types of finance lease. Deciding which is right for your business depends on your company’s current financial position and whether you want to take advantage of reduced initial payments, followed by a balloon payment (often called fixed payout leases); or a full payout lease.

In the former you sell the car at the end of the rental agreement which should cover the final balloon payment – an agreed amount that should cover the residual value of the business car.

In a full payout lease you can sell the car on behalf of the leasing company, having paid for the cost of the car in the lease rentals, and then receive up to 95% of the proceeds in the form of a rebate from the rental company.

Or, which can be quite appealing if you still enjoy driving the car, enter into a secondary rental period. This second phase of the full payout lease is often called a peppercorn rental, for the very fact it costs very little.

How do I account for a finance lease?

As we mentioned at the start, a finance lease is very much a halfway house between outright purchase and contract hire. And so it is with the accounting procedure.

For purposes of the ownership of the car, the leasing company holds title to it (although the car is shown as an asset on your company’s books).

However, there are no capital allowances available on a finance lease. Instead the rentals are fully tax deductible if your car has CO2 emissions below 160g/km; or, if the emissions are above 160g/km, subject to a 15% restriction. These business car accounting rules have replaced the old ‘half the excess’ rule since April 2009 on all new business car acquisitions.

A word of warning about finance leases

One of the advantages of finance lease – particularly for those SMEs operating vans – is that there is perceived to be less of an issue over the condition of the vehicle at the end of the lease period.

While this is true, nevertheless the condition of your company car – or business van – will have a bearing on its value when it is time to sell. And if it doesn’t make the required value, then you will be expected to fund the shortfall. So that’s something to bear in mind.

There is also the issue of the balloon payments, as Peter Leyden, Avis business solutions manager, usefully points out: “Recently, in order to make the monthly rental on finance leases look attractive, many business car funders have been incorporating balloon payments, which if set realistically can be a good thing.”

Mr Leyden continues: “As always there is a ‘however’. Some funders have been over-enthusiastic or actually unrealistic which has resulted in a shortfall at the end of the contract. This becomes apparent when the vehicle is sold and the lease provider asks the lessee for the balance. Like all things in life, if it looks too good to be true then it probably is. It is always best to get more than one quote in order to make sure you are viewing like for like and are making a properly informed choice.”

Is finance lease for you?

Given the caveats above, a finance lease is a useful way to fund your company cars, especially for those SMEs who are more attuned to the idea of owning their business cars.

You have flexibility – the ability to continue using the car at the end of the lease or not – and can take advantage of putting the lease rental (subject to private usage) against your p&l. More than that, though, is you get an opportunity to save some VAT, too.

Fleet Alliance comment on contract hire

“Finance lease is a niche product which provides a flexible alternative to other products, such as contract hire.

“It is a particularly strong offering for clients with commercial vehicles on two counts. Firstly from a mileage perspective – where a client is unsure of the mileage pattern finance lease can be more effective than contract hire, or contract purchase.

“Secondly, commercial vehicles which are prone to damage may be better served under a finance lease than they would be in a contract hire agreement. This avoids potentially penal end of contract refurbishment costs on a typical contract hire agreement.

“Whilst it is hard to envisage finance lease having anywhere near the market share of the more ubiquitous contract hire – it nevertheless remains a core part of the staple funding options for small fleets.”

Martin Brown

managing director of fleet solutions provider, Fleet Alliance

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Ralph Morton

Ralph Morton

Ralph Morton is an award-winning journalist and the founder of Business Car Manager (now renamed Business Motoring). Ralph writes extensively about the car and van leasing industry as well as wider fleet and company car issues. A former editor of What Car?, Ralph is a vastly experienced writer and editor and has been writing about the automotive sector for over 35 years.

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