In this blog, we take a look at how different types of lease and finance are treated for tax purposes. It has become increasingly common for cars and equipment to be purchased on finance in recent years (e.g. cars purchased on a PCP arrangement).
Leasing of plant and machinery including motor vehicles
Leasing involves a contract between the lessor (supplier) and lessee (customer) giving the lessee possession and use of an asset for an agreed period of time on payment of rentals or other considerations to the lessor. There are a number of different types of lease structure. The main distinction in tax is between an operating lease and a finance lease. Broadly speaking with an operating lease the person hiring the asset never obtains ownership of the asset whereas a finance lease is closer to the purchase of the asset in economic terms.
Summary of Tax Treatment
Broadly speaking there are two main tax treatments:-
For tax purposes where the lease does not have an option to purchase or there is an option to purchase but it is for full market value, a tax deduction is available for the lease payments as and when they arise. There is a 15% restriction for tax where the asset is a car and CO2 emissions exceed a certain level.
Where the lessee has an option to purchase the asset at the end of the contract, the value of the lease is included in the balance sheet in the accounts and depreciated over the life of the lease through the profit and loss account. Where the option to purchase at the end of the lease is at a price which is below the expected market value of the asset at that date, the depreciation charged to the accounts is disallowed for tax purposes. Instead, the lessee can claim capital allowances (for cars this is at either 18% or 6% per annum on a reducing balance basis depending on the CO2 emissions level). The interest charges are tax deductible as they arise. On the ultimate disposal of the asset/vehicle a full tax write-off of the balance of the unwritten-down cost of the vehicle is given.
Further details on the various types of lease are shown below.
Operating leases
An operating lease reflects the market rate for leasing the asset. The lessor retains ownership, but at the end of the period the lessee may have the option to purchase the asset for its market value. For tax purposes the lease payments are allowed as a tax deduction as they are charged in the profit & loss account. A restriction of 15% applies where the CO2 emissions rating of the vehicle exceeds a certain level.
Finance leases
With a finance lease the economic risks and rewards of ownership fall to the lessee although as a matter of law the lessor owns the asset. The asset is included in the balance sheet in the accounts and the interest element is included as a deductible expense in the profit & loss account.
Finance leases with a term greater than 5 years (long funding leases)
Where the finance lease is for a period of more than 5 years, the lessee can claim capital allowances at a rate of 18% or 6% depending on the CO2 emissions rating of the vehicle) and the interest is tax deductible.
Finance leases with a term less than 5 years
Broadly, there are two types of finance lease, those which have an option to purchase at the end (hire purchase contracts) and those which do not but allow the lessee to continue to use the asset for very little payment or require the lessor to sell the asset and pay most of the proceeds to the lessee by way of rental rebate.
Where the finance lease does not have an option to purchase at the end of its term and is for a period less than 5 years, the lessor can claim capital allowances on the asset. The lessee can claim a tax deduction for the depreciation and interest on the lease as it is charged to the income statement.
Where the lease has an option to purchase the asset at the end of the contract (for less than market value) as in the case of a hire purchase contract, the lessee can claim capital allowances on the asset and the interest is tax deductible.
Contact Us
Please contact us to find out how the above applies in your circumstances and how you can reduce your tax liabilities and maximise your tax efficiency.
Please note that the above is for general information only and does not constitute financial or tax advice. You should not rely on this information to make or refrain from making any decisions. You should always obtain independent professional advice in respect of your own situation.
