Cars: to lease or to purchase?

We often get asked by our clients for advice on the most tax efficient way to get a new car; lease or purchase? Unfortunately, the answer to this question isn’t straightforward but I have set out below the differentials which may help you to make a decision.

 

If you are a sole trader, partner or LLP member:

 

Car lease

 

If you lease a car for business purposes you’ll be able to reclaim 50% of the VAT you pay on the monthly rental charges on your VAT returns.

If the car you lease has CO2 emissions of 130g/km or less you can also claim the full net monthly lease cost plus 50% of the VAT as a deductible expense against your profits. i.e the cost of leasing the car will be charged as an expense in your profit and loss account.

If the CO2 emissions are in excess of 130g/km, 15% of the lease payments will be disallowed for tax purposes.

As well as this, you can also reclaim your other car expenses such as repairs, fuel etc. through the profit and loss account, however, any private element of the cost of running the car through the business should be adjusted through your personal tax return.

Watch out for the mileage if you complete a contract hire agreement, as there may be high charges for mileage in excess of the limit proposed by the agreement.

 

Car purchase

 

When you buy a car you can’t generally reclaim the VAT on purchase.

If you are looking at a new registration, then the value of the vehicle is depreciated the minute that you drive off the lot. You also have to tie up business capital in the asset value of the car. But you do actually own an asset rather than renting one.

If you buy the car on HP or take out a loan you can reclaim the business element of the interest charged against your profits. Only this cost would be charged as an expense in your profit and loss account.

As the car would be classed as a business asset, you can also claim capital allowances. If the car you buy has CO2 emissions of 130g/km or less you can claim 18% of the purchase price each year on a reducing basis, against your accounting profits. This isn’t shown in the accounts as this is a tax adjustment, but this will be shown on your personal tax return. Cars with CO2 emissions in excess of 130g/km will only attract an 8% deduction.

On sale of the car there would also be an adjustment to make. This would really depend on whether the car is sold for more/less than the tax written down value at that time but again the differential would be taxed/ deducted at the above rates (18% or 8%).

It is also worth bearing in mind that if you were to buy a car with CO2 emissions with 75g/km or less you can claim capital allowances of 100% against your accounting profits in the year of purchase.

As well as this, you can also reclaim your other car expenses such as repairs, fuel etc. through the profit and loss account, however, any private element of the cost of running the car through the business should be adjusted through your personal tax return.

 

If you are a director of a limited company or an employee of any entity type:

 

The above methodology still applies for business tax; however there are benefit in kind tax charges to consider. These are in place of the private use adjustments you would make on your personal tax returns if you are a sole trader, partner or LLP member.

A company car benefit is calculated by taking the initial list price of the car, reduced by any capital contribution made (maximum of £5,000) by the director/ employee and applying a chargeable percentage. Again, this percentage is determined by the car’s CO2 emissions and the higher the emissions, the higher the percentage.

National insurance is then charged to the company on the car benefit calculated (at 13.8%) and tax is charged to the director/ employee at his / her tax rate (20/40%).

If fuel is also paid for by the company on behalf of the director/ employee a further benefit is also chargeable.

 

Making a decision

 

Taking the above into consideration, the decision ultimately depends on the car you wish to drive.

The real difference between the two methods from a tax point of view is in the timing. Leasing gives you tax relief as you pay the rentals. Purchasing has slower tax relief in early years, only catching up when you sell.

 

If you would like further information on the above or would like to enquire about our assistance with car lease vs purchase calculations, please do not hesitate to contact us by calling 01772 821021.