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Equipment – Buying vs Hire Purchase vs Leasing

28th September 2012

Should I buy or lease this? Which is better for tax purposes? Just some of the common questions we receive from our clients about equipment for their company. Hopefully this blog will help solve those questions that you have about this topic as well.

Buying

The simplest situation – in this case, you buy the asset outright for cash.

  1. Potentially high up-front cost initially – possible cash flow difficulties?
  2. The assets value will depreciate over time. You cannot claim this ‘expense’ against tax, but the asset is treated under Capital Allowances.
  3. Finance charge (if you have taken out a loan) is normally allowed against tax.
  4. Can claim VAT back on most assets (except cars).

Hire Purchase

If you don’t have the capital to afford a large initial up-front cost, this may be a better option. Here the purchaser agrees to pay installments, plus interest, plus a nominal fee at the end to complete the purchase.

  1. Lower initial cost, but overall more expensive due to interest payments.
  2. Although you don’t own the asset, it is treated as if it had been for your accounts, and depreciated.
  3. Again, for tax, depreciation is not allowed – it is replaced with Capital Allowance
  4. Payment installments are recorded on balance sheet
  5. Payments are apportioned between capital repayment and interest
  6. Total interest should be shown as an expense in P&L
  7. Tax – same as above

Finance Leases

An alternative to Hire Purchase, a Finance lease typically has an initial period of fixed length at full cost, followed by a secondary period at very low cost. The business customer never legally owns the equipment, but they have most of the ‘risks and rewards’ associated with the asset, hence for accounting purposes they do ‘own’ it. They are responsible for maintenance, insurance etc of the asset. At the end of the initial period, if the customer does not want to continue using the equipment, they can arrange to sell it to a third party second hand, and obtain the bulk of the proceeds.

  1. For accounting purposes, finance leased assets are treated in the same way as hire purchase.
  2. Capital Allowances are not available, but depreciation is allowed (You will never see this ever again)
  3. VAT charged by the finance company is payable on the initial installment and each subsequent rental.
  4. For cars, most businesses will be able to recover 50% of the VAT.

 

Operating Lease

This is easy – just renting the equipment.

  1. This option is popular – generally cheaper overall and often comes with a related maintenance contract (depending on the equipment)
  2. Common where an established second-hand market exists (cars, construction and office equipment etc)
  3. Lease period typically 2-3 years, always less than working life of asset.
  4. Not listed on balance sheet – entire operating lease cost is shown on P&L.
  5. No capital allowances
  6. VAT added to each rental installment, so cost is spread throughout lease period.
  7. If car, can reclaim 50% of VAT.
  8. Any maintenance VAT may be reclaimed in full (if it can be identified separately).