Contract hire tax benefits for businesses
Car leasing normally falls into two main types:
Operating leases (contract hire) – Click for our main Contract Hire Guide.
Operating Leases within the car market are generally referred to as ‘contract hire’. For a set monthly rental the leasing firm, otherwise known as the lessor, provides a package that normally covers everything (maintenance etc) except fuel and insurance. The agreement typically lasts either two or three years, and at the end of the agreement the car is handed back to the leasing company. Provided the car hasn’t gone over the mileage allowance that was originally agreed and is in a reasonable condition, no more money is due. For more information on reasonable condition, check our Wear & Tear Guide.
Finance Leases – Click for our main Finance Lease Guide.
With a finance lease, the monthly rentals tend to be calculated to meet the cash flow needs of the business. At the end of the lease the customer, or the lessee, usually receives the major share of the sales proceeds.
Offset against taxable profits
When it comes to contract hire, the monthly payments the company pays during the year are normally fully offset against its taxable profits, therefore capital allowances can’t be claimed as well. However, the payments can’t be fully offset against its profits if:
- The car has CO2 emissions over 160g/km
- The rentals aren’t evenly spread over the life of the lease, or
- The lease has clauses that may allow the company to eventually own the car.
To encourage the leasing of more environmentally friendly cars, for cars emitting 161g/km or over of CO2 15% of the rental will not get any tax relief. That is, only 85% of the rental can be offset against taxable profits.
Example 1 – Car with CO2 emissions of 160g/km or less:
A company takes out a contract hire agreement for a car with CO2 emissions of 129g/km over three years (we will assume it does it in the first month of its financial year). The contract hire deal is a 6+35, which means six payments upfront followed by 35 monthly payments of £300.
- Year 1
The company pays 17 rentals (six plus 11) 17 x £300 = £5,100 which can be offset against taxable profits. Assuming the company has a 26% tax rate this means it gets tax relief of £1,326 (£5,100 x 26%).
- Year 2 & Year 3
The company pays 12 rentals 12 x £300 = £3,600 each year which can be offset against taxable profits. It gets tax relief of £936 each year (£3,600 x 26%).
Example 2 – Car with CO2 emissions of 161g/km or more:
A company takes out a 6+35 at £300 per month, three-year contract hire agreement on a car that emits 199g/km of CO2.
- Year 1
The company pays 17 rentals (6 plus 11) 17 x £300 = £5,100 of which 85% can be offset against taxable profits. This means the company gets a tax relief of £1,127.10 (£5,100 x 85% x 26%)
- Year 2 & Year 3
The company pays 12 rentals 12 x £300 = £3,600 each year which can be offset against taxable profits. It gets tax relief of £795.60 each year (£3,600 x 85% x 26%).
With leases, the rentals the company pays during the year tend to be offset against its taxable profits therefore capital allowances can’t be claimed as well.
Since 1995, businesses that acquire cars wholly for business use may recover the VAT. This change meant that lessors (who never actually use the car at all) can use the extra savings to reduce their lease rentals. Despite the rule restricting the VAT available to the user of leased cars to 50%, the overall effect has seen a huge increase in the amount of leased cars.
If the company is VAT registered if can claim 100% of the VAT back on any maintenance rental.
If in any doubt, a business should seek professional help before committing to a long-term contract.