When considering how to finance a vehicle for your business, two common options are Hire Purchase (HP) and Lease agreements. While both methods can help you acquire a vehicle, the VAT treatment differs significantly. It’s essential for businesses to understand these differences, as they can have a direct impact on your VAT reclaim options and overall financial strategy.
As a general rule, you cannot recover the VAT on the purchase. But if you buy or acquire a vehicle that is intended to be used primarily as a taxi, driving instruction car, or self drive hire, you can recover the VAT in full.
In this article, we’ll explore the VAT implications of both options and provide a comparative example to illustrate how each might affect your business.
VAT on a Vehicle Purchase through Hire Purchase (HP)
Under a Hire Purchase (HP) agreement, the business effectively purchases the vehicle over time through monthly payments. At the end of the agreement, ownership of the vehicle transfers to the business.
The key VAT consideration with a Hire Purchase agreement is that VAT on the purchase price of the vehicle is fully blocked. This means that your business cannot reclaim the VAT on the cost of the vehicle itself, even if it is used for business purposes.
This occurs because the HP agreement is treated as a finance agreement by HMRC. Since the business does not own the vehicle until the final payment is made, it is considered a form of credit purchase, and VAT cannot be reclaimed upfront.
However, VAT may still be applicable to other services, such as maintenance, that are associated with the vehicle. Depending on the nature of these services and how the vehicle is used, these VAT charges might be reclaimable. For instance, if the lease agreement includes maintenance costs, VAT on the maintenance portion of the lease is fully recoverable, even for mixed-use cars.
Key Takeaway: With a Hire Purchase agreement, the VAT on the vehicle’s purchase price cannot be reclaimed, but VAT on additional services may be recoverable.
VAT on a Vehicle Lease
When a vehicle is acquired under a Lease agreement, the VAT treatment is different. Leasing is a rental arrangement rather than a purchase, and as such, VAT is applied to the monthly lease payments. This makes the VAT treatment of lease payments different from hire purchase (HP).
The key VAT advantage with a Lease agreement is that you can reclaim 50% of the VAT on the monthly payments, even if the vehicle is used for both business and personal purposes. If the vehicle is used exclusively for business purposes, you may be able to reclaim 100% of the VAT on the monthly payments. Businesses must keep detailed records to prove exclusive business use if claiming 100%.
Unlike a Hire Purchase agreement, leasing involves paying for the use of the vehicle rather than purchasing it outright, which is why VAT on the monthly payments can be reclaimed by businesses, making it more manageable for cashflow.
Key Takeaway: With a Lease agreement, 50% of the VAT on monthly payments can be reclaimed, or 100% if the vehicle is used solely for business purposes.
Comparative Example
To better understand the VAT implications of both options, let’s look at an example where a business acquires a vehicle worth £20,000 (excluding VAT) through both Hire Purchase and Lease agreements.
Example 1: Hire Purchase Agreement
- Vehicle Purchase Price (excluding VAT): £20,000
- VAT on Vehicle: £4,000 (20% VAT)
- Total Vehicle Cost (including VAT): £24,000
- VAT Reclaimable: £0 (VAT is fully blocked on the purchase of the vehicle)For an HP agreement, the business cannot reclaim VAT on the £4,000 VAT charged on the vehicle.
Example 2: Lease Agreement
- Vehicle Lease Monthly Payment (excluding VAT): £500
- VAT on Monthly Payment: £100
- Total Monthly Payment (including VAT): £600
- VAT Reclaimable on Monthly Payment (50%): £50
In this example, with a Lease agreement, the business can reclaim 50% of the VAT on the monthly payments. If the business uses the vehicle for 100% business purposes, it can reclaim the full £100 VAT on the monthly payment, instead of just £50.
Summary of the Two Options:
| Option | Vehicle Purchase Price (excluding VAT) | VAT on Vehicle | VAT Reclaimable |
|---|---|---|---|
| Hire Purchase (HP) | £20,000 | £4,000 | £0 (VAT blocked on purchase) |
| Lease | £500 per month | £100 per month | £50 per month (50% reclaimable) |
Which Option is Best?
The decision between Hire Purchase and Lease agreements ultimately depends on the specific needs of your business. Here’s a quick summary of VAT considerations:
- Hire Purchase (HP): No VAT reclaimable on the vehicle purchase, but VAT on other services like maintenance may be recoverable.
- Lease: 50% VAT reclaimable on monthly payments, or 100% if the vehicle is used exclusively for business purposes.
When it comes to what option is best for your business, it’s important to see the bigger picture and not get too caught up on VAT alone. Remember that when buying or leasing a vehicle, it is not just VAT that gets affected, but also things like Corporation Tax & P11d’s. Therefore, for some businesses it may actually be worth taking the hit on the VAT on HP as you will have full benefit from a Corporation Tax point of view. With things like this, it really does pay to consult with a tax expert, so reach out to our team to discuss the specifics of your business.
We’re Here To Help Your Business
Understanding the VAT treatment of Hire Purchase and Lease agreements is essential when financing a vehicle for your business. While Hire Purchase agreements block VAT on the vehicle’s purchase price, leasing offers a VAT reclaim option on monthly payments, which can be more beneficial for businesses that need to reclaim VAT on ongoing costs.
If you’re unsure which option is best for your business, or if you need further guidance on VAT treatment, it’s advisable to consult with a professional accountant who can help you make the most tax-efficient decision. At Nordens we offer expert advice and assistance with all of your business needs: from your everyday accounting to Advisory, Tax, Audit and more. If you need support with any of the above or just want to speak to a member of the team, get in touch today.
