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Tax considerations in Asset Finance

by Eamonn McMahon

With the business tax burden now at it’s highest level for some years, it essential to have a firm grip on the tax implications of acquiring equipment with asset finance, and to understand the impact of choosing one form of asset finance over another. In this short blog we will seek to clearly lay out the differences in tax treatment so that as a small business you know exactly where you stand. As a small company director myself, I know how clear and certain data is critical when making decisions and I hope this post helps.

Firstly, some historical context:

Back in the 1970’s and 80’s, tax was a big driver of asset finance and leasing. Lessors could benefit from a 100% capital allowance in the first year of leasing an asset and when corporation tax rates were over 50%, leasing out assets was a key component of tax policy for any financial conglomerate. Leasing and tax were bed fellows and many people today still associate leasing as a tax reduction strategy. Well put simply, reducing tax is no longer the key driver of asset finance and leasing although it is still a consideration.

VAT

Regardless on if equipment is funded via asset finance, VAT is payable on both used and new equipment if the vendor sells more than £85,000 of equipment p.a so 99.99% of the time VAT is absolutely a consideration. At the time of writing this blog post, there is talk that the government might increase the VAT threshold substantially which will simplify, (if not necessarily optimise!) matters for smaller companies but we will have to wait and see. While VAT can generally be offset it can have a significant effect on cash flow for a small business acquiring a large piece of equipment.

With Hire Purchase, the supply of goods to the Customer/Hirer is deemed to have been made at the onset of the contract, so VAT is due in full at commencement of the contract. Some funders will offer a VAT loan or holiday where customers may have up to 90 days to pay the VAT and it is always worth checking if this is the case.

What about imported equipment you might ask? What if the equipment is imported and financed by way of a Sale and HP agreement? Well assuming the equipment vendor sells over £85,000 in the UK and is VAT registered (99% the case), the Customer (or Hirer) will once again have to pay the VAT. Then, with a Sale and HP agreement the Customer sells the equipment to the funder to hire it back over time before ultimately have the option to purchase it for a peppercorn amount.

With a Finance Lease, no supply of goods is deemed to have been made but rather the initial installment and each subsequent lease payment is subject to VAT as part of a service provided. The Lessor (the company funding the equipment for you) will purchase the equipment and pay the VAT and you will pay VAT on each monthly payment you make over the term of the deal.

With a Contract Hire or Operating Lease, VAT is added to every payment you make until you terminate. The contract hire or operating lease will usually include service and maintenance.

TAKE AWAYS🥡:

1. VAT is payable on Hire Purchase contracts up front. 20% on the total cost of the equipment regardless of deposit level.

2. Non-VAT registered businesses might want to consider a finance lease/contract hire/operating lease as the payment of VAT is spread out over the term of the lease.

3. With any type of lease (i.e. not a HP contract), VAT is levied on all payment amounts including the effective finance charge so more VAT!

Corporation Tax

It is essential for any company that we consider Corporation tax or tax on profits. Corporation tax currently starts at 19% for businesses with less than £50,000 of profit and rises steadily to 25% for businesses who generate £250,000 of profit on the back of recent efforts to increase the government tax take.

Investment in equipment without funding will typically allow the business to claim a Capital Allowance (also known as a ‘plant and machinery allowance’.)

Note: Over the pandemic period, the government introduced special tax incentives to encourage investment in equipment and machinery referred to as a the Super Deduction Allowance and the Special Rate Allowance but these expired on 31st March 2023 and will not be covered here.

There are several different Capital Allowances you can choose from but you are only able to apply one allowance to one item of equipment investment.

For most growing businesses, the Annual Investment Allowance is the key Capital allowance to utilise. The business can claim 100% of equipment investment, up to a value of £1M in a year, as a deduction against taxable profits. So if the Company invested £100k + VAT in a machine and otherwise generated taxable profits of £500k, the company could reduce its taxable profit to £400k.

With a Hire Purchase contract, the supply of goods is deemed to have been made to the end Customer, so the full Annual Investment Allowance can be claimed by the Customer in Year 1. In addition, the portion of the HP rental that can be attributed to finance costs can be expensed against tax. Overall, for a business that is facing a significant profit, and where that business could benefit from the availability of cash in the future, investing in equipment using Hire Purchase finance is tax efficient.

With a Finance Lease contract and also with an Operating Lease/Contract Hire contract, the Customer (or strictly speaking, the lessee), doesn’t benefit from Capital Allowances but instead the full lease payments are allowable as an expense each year against profit. Hence with a finance lease, there is generally more tax benefit in future years so again it is arguably a better solution for loss-making or early stage companies.

Note: We are exclusively looking at ‘short leases’ here where the term is less than 84 months.

The fact that the Funder or Lessor benefits from the Capital Allowances, is one of the reasons why Finance Lease payments are usually lower than the equivalent HP payment. The main reason however is of course being the ownership of the residual equipment value at the end of the term.

Other Tax Considerations

Outside of VAT and Corporation Tax it is worth considering other tax implications linked to asset finance.

Cars attract special rules. Typically the VAT cannot be reclaimed if the car is bought with cash or under a Hire Purchase contract. If financed with a finance lease, only 50% of the VAT on lease payments will be recoverable. With an operating lease, the full VAT on the maintenance component will be recoverable.

Hopefully the above post is useful for Directors of small businesses and the trusted professionals who serve them. We are always here to support over Intercom (bottom right corner!) , WhatsApp for Business or good old fashioned telephone (07947 540798) /email (info@equipal.co). Please reach out. Until then we trust you will reach safe harbour!

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