Funding Methods - Finance Lease

Finance lease is a good halfway house between owning your company car and outright business car usership known as contract hire.

Finance lease has all the benefits of ownership, but many of the cash flow and VAT advantages of contract hire.

VAT advantages of finance lease

VAT is charged on the rentals of a finance lease. Assuming there will be some private use of the company car, 50% of the VAT can be reclaimed.

There is a further advantage to finance lease. The finance company providing the car can reclaim the full 100% of the VAT on the purchase of the vehicle; it can then pass on this VAT saving in the form of lower rentals to you.

Cash flow advantages of finance lease

There are two types of finance lease. Deciding which is right for your business depends on your company's current financial position and whether you want to take advantage of reduced initial payments, followed by a balloon payment (often called fixed payout leases); or a full payout lease.

In the former you sell the car at the end of the rental agreement which should cover the final balloon payment – an agreed amount that should cover the residual value of the business car.

In a full payout lease you can sell the car on behalf of the leasing company, having paid for the cost of the car in the lease rentals, and then receive up to 95% of the proceeds in the form of a rebate from the rental company.

Or, which can be quite appealing if you still enjoy driving the car, enter into a secondary rental period. This second phase of the full payout lease is often called a peppercorn rental, for the very fact it costs very little.

How do I account for a finance lease?

As we mentioned at the start, a finance lease is very much a halfway house between outright purchase and contract hire. And so it is with the accounting procedure.

For purposes of the ownership of the car, the leasing company holds title to it (although the car is shown as an asset on your company's books).

However, there are no capital allowances available on a finance lease. Instead the rentals are fully tax deductible if your car has CO2 emissions below 160g/km; or, if the emissions are above 160g/km, subject to a 15% restriction. These business car accounting rules have replaced the old 'half the excess' rule since April 2009 on all new business car acquisitions.

A word of warning about finance leases

One of the advantages of finance lease – particularly for those operating vans – is that there is perceived to be less of an issue over the condition of the vehicle at the end of the lease period.

While this is true, nevertheless the condition of your company car – or business van – will have a bearing on its value when it is time to sell. And if it doesn't make the required value, then you will be expected to fund the shortfall. So that's something to bear in mind.

Is finance lease for you?

Given the caveats above, a finance lease is a useful way to fund your company cars, especially for those who are more attuned to the idea of owning their business cars.

You have flexibility – the ability to continue using the car at the end of the lease or not – and can take advantage of putting the lease rental (subject to private usage) against your p&l. More than that, though, is you get an opportunity to save some VAT, too.