Contract Hire for Business – What are the Tax Implications?
Leasing company cars and vans, rather than buying them outright, is now well established for businesses. It provides known, easily budgeted costs with no hidden surprises and predictable cash-flows. The most popular type of vehicle leasing for businesses is contract hire. It’s a form of operational leasing which allows the end user or lessee to hire a car for a set period of time and pre-determined mileage, in return for a monthly contract hire rental.
This provides a package that normally covers everything required to drive the vehicle away, except fuel and insurance, while maintenance is typically available for an additional sum.
The monthly contract hire rental takes into account a range of items. These include:
- the cost of the car
- vehicle registration fees
- road tax
- period of use
- agreed mileage
- funding costs
- forecast residual value, which is the car’s estimated value at the end of the contract.
There is usually no option to purchase the vehicle at the end of the contract hire period. It is returned to the supplying leasing company and reviewed for condition and mileage driven.
What are the benefits of contract hire for businesses?
For a business, contract hire removes most of the risk of operating company cars. The major risk of disposal of the vehicles at the end of contract and fluctuations in used car values is borne by the leasing company.
There is a known, fixed monthly cost which makes budgeting straightforward. This helps reduce impact on cash-flow which can be invested elsewhere in the business or used for other purposes.
There are also a number of tax implications surrounding business car leasing. Businesses need to understand these to derive the maximum benefit from the agreement.
Tax deductible payments for contract hire
The monthly contract hire payments made during the year can normally be fully offset against the business’s taxable profits for corporation tax purposes. However, there are a number of provisos and impending changes which should be considered.
The payments are not fully tax deductible if:
- The car has CO2 emissions over 110g/km (this has recently reduced to encourage companies to select greener cars)
- The rentals aren’t evenly spread over the life of the lease, or
- The lease has clauses that may allow the company to eventually own the car.
From April 1st 2018, cars emitting 111 g/km or more of CO2 will be subject to a 15% tax disallowance on the amount of the rental that can be claimed against the business’s taxation. Only 85% of the value of the car leasing costs qualify for tax relief against corporation tax. This new threshold replaces the 130g/km threshold which has been in place for several years – existing cars will not be affected.
For cars contract-hired by the business with a CO2 output of 110g/km or below, there will be no disallowance. Tax relief on the car leasing costs can be fully allowed against taxable profits – making business contract hire very tax efficient.
This does mean, however, that capital allowances cannot be claimed as well. These stay with the owner of the vehicle, in this case the contract hire company.
What is the situation regarding VAT and contract hire?
Since 1995, businesses that acquire cars using contract hire wholly for business use may recover the VAT.
This change meant that the contract hire supplier could use the extra savings to reduce their lease rentals, further increasing the popularity of business contract hire.
The monthly contract hire rental is often typically split into two elements – finance and maintenance.
If the car has no private use and is used wholly for business purposes, such as a taxi, a VAT-registered business can reclaim 100% of the VAT paid on the finance element,
If there is any degree of private use – which applies to the overwhelming majority of company cars in the UK – then only 50% of the VAT on the finance element can be reclaimed.
However, if maintenance is provided with the car, the business can claim 100% of the VAT back on the maintenance element of the rental, provided these costs can be separately identified.
Benefits of business contract hire
Contract hire offers businesses a number of other benefits including:
- Tax-efficiency with Corporation Tax and VAT benefits
- Off-balance sheet funding for most organisations (read about the new accounting standards here)
- Improved cash-flow with minimal capital expenditure
- Known fixed motoring costs for the contract period, leading to accurate budgeting
- Optional monthly maintenance charge covering routine maintenance and servicing costs, to smooth out motoring expenditure even further
- Low risk with no uncertainty over future residual values, nor the hassle of disposing of the vehicle
- Reduced in-house administration, freeing up staff time
- Optional breakdown and replacement vehicle cover
- Road Fund Licence provided for the duration of the contract
When is contract hire not ‘off-balance sheet’?
One of the advantages for some businesses is that assets on contract hire do not need to be shown on their balance sheet. This can be important for certain key gearing or lending ratios.
However, a new international lease accounting standard, IFRS 16 Leases, comes into play from January 1st 2019. This covers the future accounting treatment of leased assets, including those on contract hire. Whilst adoption of the standard isn’t expected in the UK for another four or five years, it is worth starting to consider it with most lease agreements running for 3 year periods.
In its international format, the new standard is intended to bring all assets on leases of more than 12 months’ duration onto a company’s balance sheet, giving a more complete picture of a business’s financial commitments.
This new approach will have different implications for different companies depending on factors such as size, profitability, attitude to risk, ownership of assets and a host of other issues.
If you need any further information on the contract hire options available to your business, please don’t hesitate to get in touch.