Over the years I have often been asked what is the difference between buying, leasing or using HP to obtain that needed extra piece of equipment. The answer really is different from one company to the next, but here are the general guidelines concerning how they are treated for accounting, Tax and VAT purposes.
Outright Purchase:
From an accounting viewpoint the actual cost of the asset is capitalised in the balance sheet and an annual charge for depreciation is shown in the accounts as an expense in the profit and loss account. This therefore has the effect of showing the asset(s) in the balance sheet at cost, reduced by the cumulative charge for depreciation.
The annual depreciation charge is calculated in accordance with accounting standards, based on the useful economic life of the asset and the residual value.
The actual charge for depreciation is not allowed for tax purposes, as this is replaced by capital allowances, which is HM Revenue & Customs deduction regime for allowing capital expenditure against chargeable profits. The first £50,000 of expenditure each year on plant and equipment, excluding cars, qualifies for a 100% capital allowance deduction. Expenditure in excess of £50,000 enters either the 10% pool or the 20% pool, attracting a writing down allowance (WDA) at the appropriate rate.
A temporary first year allowance of 40% is available for expenditure on plant and machinery that exceeds the annual investment limit incurred in the year commencing on 1 April 2009 (corporation tax) or 6 April 2009 (income tax). This allowance applies to expenditure which would otherwise have been allocated to the main 20 % pool but excluding cars and assets for leasing.
Unless the asset is a car, the VAT shown on the supplier's invoice will generally be recoverable by the purchaser. VAT on cars is recoverable only in very rare circumstances.
A HP agreement usually includes an option to purchase at the end of an initial period. Payment of this nominal fee transfers title of the asset and brings the legal agreement to an end.
The asset is treated as if it had been purchased. It is, therefore, capitalised in the balance sheet and depreciation is provided on an annual basis.
The obligation to pay future instalments is recorded as a liability in the balance sheet.
The payments are apportioned between a finance charge and a reduction of the outstanding liability.
The total finance charge should be allocated to accounting periods during the HP term and is shown as an expense in the profit and loss account.
The actual charge for depreciation is not allowed for tax purposes, as this is replaced by capital allowances, which is HM Revenue & Customs deduction regime for allowing capital expenditure against chargeable profits. The first £50,000 of expenditure each year on plant and equipment, excluding cars, qualifies for a 100% capital allowance deduction. Expenditure in excess of £50,000 enters either the 10% pool or the 20% pool, attracting a writing down allowance (WDA) at the appropriate rate.
A temporary first year allowance of 40% is available for expenditure on plant and machinery that exceeds the annual investment limit incurred in the year commencing on 1 April 2009 (corporation tax) or 6 April 2009 (income tax). This allowance applies to expenditure which would otherwise have been allocated to the main 20 % pool but excluding cars and assets for leasing.
The finance charge in the accounts is normally allowed against tax.
VAT charged by the finance company will be payable with the initial installment. In the case of a car, most businesses will be unable to recover any of the VAT.
A finance lease typically has a primary period for a fixed period at full cost, followed by a secondary period, usually of an indefinite length, at a very low cost.
The asset is treated as if it had been purchased. It is therefore capitalised in the balance sheet and depreciation is provided on an annual basis.
The obligation to pay future rentals is recorded as a liability in the balance sheet.
The rents payable are apportioned between a finance charge and a reduction of the outstanding liability.
The total finance charge should be allocated to accounting periods during the primary lease term and is shown as an expense in the profit and loss account.
Where accounts have been prepared in accordance with accounting standards, the accounting treatment will be acceptable for tax purposes and no adjustments to profit need be made.
Where accounts have not been prepared in accordance with accounting standards, for tax purposes the rentals are deductible in computing profits under the accrual concept. The rentals are, therefore, allocated over the period of the lease.
Capital allowances are not available.
VAT charged by the finance company will be payable with the initial installment and each subsequent rental. In the case of a car, most businesses will be able to recover 50% of the VAT.
An operating lease is where an asset is rented for a period, not necessarily fixed, and returned to the owner at the end of the period. Contract hire is a typical form of operating lease.
The asset is not capitalised; the rental payments are charged on an acceptable basis over the lease term to the profit and loss account.
The accounting treatment is an acceptable treatment for tax purposes, where the accounting standard has been applied. No adjustments to profits, therefore, need be made.
Capital allowances are not available.
Each rental or installment will have VAT added so that the VAT cost is spread throughout the period of the agreement.
Where the asset is a car, only 50% of the VAT on the leasing charges can be reclaimed. If identified separately, the VAT on any maintenance element of the contract can be reclaimed in full.
The disposal proceeds of leased cars will be VAT inclusive.
Please be aware that these allowances change from time to time so please check with your accountant before entering any agreement.
Make certain you that you enter into the right agreement for your company. If in doubt contact your trusted broker, otherwise you may not be maximizing your resources and wasting your hard earned cash.
