Should I buy or lease a vehicle for my business? As your business grows, you may find you or your team are required to spend more time out on the road. You know you need to add extra vehicles to your setup as you keep expanding, but should you lease or buy a vehicle for your business? Whether it’s your first or you’re adding to your existing lineup, bringing a vehicle on board is a big decision. Maybe you heard your pal’s accountant say buying a vehicle is a no-brainer as you can offset it against your tax. But is it quite that straightforward?
The first thing to consider is the business case for getting the vehicle. We’ve heard many stories of accountants advising business owners to buy a new car or van to reduce their taxes. That’s not a good basis for making this decision! Think about it this way: if you don’t really need it, it means for every £1 spent you’ll be saving considerably less in tax. The first rule is, if you don’t need it, don’t buy it.
Before thinking about the make and model, you need to decide how you’ll fund it. Both buying and leasing have individual benefits which go beyond just financial, and there is a multitude of factors to consider. In fact, we’ve dedicated a whole other blog to the tax implications of buying vs leasing a vehicle!
Both buying and leasing have their financial advantages and disadvantages, and the best option is not as clear-cut as night and day. We’ve summarised the financial pros and cons of each, so you can understand how they would apply to your business.
Buying a vehicle: the financial pros
● You have total control over what you do with the vehicle. You aren’t tied into a contract and can sell it whenever you want.
● Depending on the type of vehicle, the purchase cost may be fully tax-deductible in the first year. For example, vans (subject to you not exceeding your annual investment allowance) and electric cars. Even if you can’t claim a full write-down in year one, you’re likely to be able to claim a tax deduction over a number of years. CO2 emissions determine how quickly you get your tax deduction for cars. The rules on vehicles are ever-changing, but we’ve provided a brief summary of what to think about at the end.
● You have a tangible asset. Even if its value is decreasing, it’ll probably still be worth something in a few years.
Buying a vehicle: the financial cons
● The vehicle’s sale value dramatically diminishes as soon as you drive it out of the dealership.
● It’s a significant upfront investment, so you’ll need to take into account the immediate impact on your cash flow.
● Taking out a bank loan to cover the upfront cost will create higher monthly payments and could affect your ability to take out other loans.
● Dealership financing deals might be easier to obtain, but can be more expensive than bank loans.
There are several different types of leases which have their own characteristics
Before we get to the pros and cons of leasing, it’s worth pointing out that leasing is often used as a generic term. There are actually three different types of leases which have very different treatments.
Watch out for those salesmen who promise your rental payments will be fully offset against tax. Yes, they can, but you may also get a tax deduction if you buy outright, purchase through hire purchase, or (under certain circumstances) under a finance lease. In fact, the tax deduction you receive under these methods will often be higher in the initial years than the deduction you receive for rental payments.
- Operating lease
This is a rental agreement. You are agreeing to “rent” the vehicle for a period of time. You don’t own it and it won’t appear on your balance sheet as an asset. When signing up for this type of lease, you’ll often be asked for 2-3 months of rental payments upfront. The amount you receive as a tax deduction is the amount of the rental payment, plus any portion of the VAT which you can’t recover.
- Finance lease
In this lease, the leasing company will retain legal ownership of the vehicle, but it’s a bit different from an operating lease. To be treated as a finance lease, there needs to be a substantial transferral of all the risks and rewards of ownership. For you, that means you’re treated as receiving the benefits of ownership, so the asset will appear on your balance sheet. However, you don’t actually own the asset (the lease company does) and you’ll receive a monthly charge split between capital and interest, much like a loan.
Where it becomes tricky is that, because you don’t own the asset, you can’t claim capital allowances against it (except under certain limited circumstances). In practice, that means you only receive a tax deduction for a relatively small proportion of the lease cost: the amount that’s treated as the interest element. These types of leases can vary in their tax treatment, so careful consideration of the actual lease terms is essential.
At the end of the lease period, you may have the option to continue leasing the vehicle by paying a “peppercorn rental”. This is a small annual lease payment which allows you to keep using the vehicle without the expense of the full lease costs.
- Hire Purchase (HP)
When you enter this lease, you’ll have to pay the equivalent of the vehicle’s VAT as a downpayment. For instance, if you buy a van for £20,000 plus VAT, you’ll be asked to pay £4,000 upfront to cover the VAT. The balance of £20,000 will be financed over the agreed term of the lease. If you’re VAT registered, good news: you can claim back the VAT amount in your next VAT return. However, for cars, the amount of recoverable VAT may be restricted.
In some cases, the HP company will offer you reduced monthly payments by using a “balloon payment”. This is a one-off final payment at the end of the lease, after which you’ll have full ownership. Even if there’s no balloon payment, there will be a small documentation fee required with the final lease payment to fully transfer ownership to you.
Although this type of lease involves making monthly payments, HP is treated very much like outright ownership when it comes to tax deductions. You’ll be able to claim capital allowances or the annual investment allowance, subject to the rules relating to the type of vehicle. This will reduce your tax bill, plus the asset will also appear on your balance sheet.
Now you know a bit about how the different types of leases work, we can look at the pros and cons.
Leasing a vehicle: the financial pros
● It can be a more cost-effective option for businesses wanting to free up immediate cash flow.
● Fixed monthly payments mean you know exactly what you’re spending each month.
● You will be able to claim back some of the vat. For a commercial vehicle, with incidental private use, this will be 100%. For a car, it will only be 50%. There are some exceptions to this, like if it’s used in the business as a qualifying vehicle, i.e. as a taxi or an instructional driving vehicle.
● Smaller payments mean you’ll be able to afford updated vehicles that would otherwise be out of your price range.
● Leasing companies have great buying power, so you’re likely to find a good deal.
Leasing a vehicle: the financial cons
● Going from one lease to another can add up to higher costs over the long run, compared to buying the vehicle upfront. The leasing company will be making a profit on the vehicle, as well as receiving additional profit through their funding charges which will be built into the cost of the lease. If circumstances change and you no longer need the vehicle, you might have to pay a hefty amount to terminate the lease early.
● Under operating leases and finance leases, you don’t own the asset. This means you don’t have any trade-in value against your next vehicle. With a hire purchase, you have the option to own the vehicle at the end of the HP period, so you’ll have an asset to use as a trade-in against a newer vehicle.
Maintenance costs should be taken into account
How you take care of your vehicle’s maintenance will depend on whether you buy or lease. Buying a vehicle means the responsibility of upkeep and maintenance is solely in your hands; you’ll need to fund any repairs and schedule the maintenance.
Leased vehicles often include some form of covered maintenance and repairs, depending on the agreement. They usually cover basic wear and tear, but anything out of the ordinary won’t be covered and could result in fines. If your business needs a van instead of a car, it might be a good idea to buy it outright to avoid these maintenance fines, as vans are prone to wear and tear if transporting heavy goods.
Your decision should take into account your mileage requirements
Before investing in a vehicle for your business, make sure you’ve clearly defined your expectations of its use. What sort of trips will it be used for? How many miles is it expected to travel?
Lease agreements come with an allowance of how many miles you’re allowed to travel in that vehicle. Exceeding the allowance will incur mileage fees which can add up quickly as an unexpected cost. If you require a vehicle to cover extensive miles, it could be more cost-effective to buy it outright as there won’t be any limit on your mileage.
You must make the decision based on your specific needs
There’s no one-size-fits-all answer for whether buying or leasing a vehicle is better. Whichever route you choose has advantages and disadvantages, but some will be more applicable to your business than others. Whether you lease or buy, bringing a new vehicle into your business is a significant decision. These decisions don’t have to feel daunting, and you don’t have to make them alone.
At One Accounting, we support established owner-managed businesses making these big decisions that bring their goals to life. We’re here to help you figure out the best options for your business by deep-diving and answering any questions you may have in this period of growth. Get in touch by filling out our form, and we’ll see if we’re a great match to start an awesome partnership together.
