Hire purchase and lease rental agreements are commonly entered into by businesses to obtain a wide range of assets in debt finance, which can be anything from office equipment to vehicles. To help you get a handle on these two very specific finance facilities, we’ve outlined the main differences between them and how they are both taxed.
What is a Hire Purchase?
When setting up or growing your business, you may need access to new equipment, tools and vehicles, but what happens if you don’t have the capital to buy them immediately? Hire purchase (also known as a credit sale) is one option that allows you to own the asset as soon as you sign the agreement, but the benefit is that you pay it off in instalments. Since the asset becomes your responsibility from the outset, you’re liable for any maintenance, insurance and servicing – just like buying something outright.
While a hire purchase allows a business to get the equipment that’s needed without the huge initial outlay; the downside is that you’ll end up paying more overall. You’ll most likely get charged a set-up fee, deposit, and interest along the way. If you can’t keep up with your payments, the asset may be repossessed.
What is Leasing?
Leasing (also called an operating lease) is an option that allows your business to borrow equipment with a contract. While it's rare you will end up owning the asset, you’re often not responsible for things like maintenance and servicing. Unlike hire purchase, you don’t have to put down a huge amount of cash up front, so it can be a great option when buying a larger asset.
The main attraction of leasing is the ability to continually upgrade your trade business assets (things like specialised equipment, tools, or vehicles) when your lease rental comes to an end. Constantly investing in all the latest equipment isn’t viable for most businesses, so leasing allows you to keep up with new technology in a more affordable way and takes away the worries of wear and tear on equipment.
Both hire purchase and leasing give your business the ability to make use of the asset. The machinery or equipment will be there in your workshop, warehouse or office for your employees to use as part of your operational processes. However, there’s a big difference when it comes to the tax equation of the assets.
The Tax Equation
From a tax relief perspective, hire purchase and leased assets behave differently. Leased assets are viewed as operating costs and are typically tax-deductible in the period of hire, whereas hire purchase items appear as an asset on your balance sheet and get tax relief in full in the year of purchase. Knowing whether you’re entering a hire purchase, or a lease rental agreement is important for two reasons:
- The choice of finance will affect your tax liabilities in the future.
- The way you pay these taxes will have an impact on your cash flow position.
The timing of VAT claims and tax relief can have a significant effect on cash flow, so it’s important to make sure that you know whether you’re going down the hire or lease route.
Under a hire purchase agreement, there will usually be a deposit equal to, or more than, the VAT on the cost of the asset. The VAT can be claimed back from HMRC using the hire purchase document. Under a Lease rental agreement, there is VAT on the payments made. The lessor will issue VAT invoices which can be used to claim back the VAT from HMRC.
Helping you Make the Best Financial Decisions
To find out more about how hire purchase or lease rental can help your business grow, and to discuss which one may be better for your circumstances, get in touch with Hysons, Chartered Accountants, today for a no-obligation discussion.
Here at Hysons, Chartered Accountants, we are a highly qualified and knowledgeable team, ready to provide any advice and help you may need with business accounting services. To find out more or to get a quote, contact us today.