Considering your options in leasing and sourcing finance

Hire and lease purchase contracts normally involve paying a deposit and then monthly or quarterly payments for the hire or lease of the equipment. At the end of the contract, for a nominal fee, the legal title (ownership) of the equipment passes to the lessee. In the accounts, the equipment is normally capitalised on the balance sheet as a fixed asset from the date the hire or lease contract is signed and the equipment received.

The tax treatment of this is that you are generally allowed to claim capital allowances on the whole capital value of the asset, which means accelerated tax relief. However, a liability is also set up in the accounts to show the remaining deemed loan element of the purchase contract. The interest element incurred on the hire/lease purchase agreement is charged as a tax allowable expense to the profit and loss account.

Finance leases are those that transfer substantially all the risks and rewards of ownership to the person who is leasing the equipment, even if the legal title (ownership) will not be transferred. Without going into too much detail here, and subject to ongoing accounting standard technical developments, it has historically been presumed where the present value of minimum lease payments amounts to “substantially all” or 90 per cent or more of the fair value of the leased asset, then it will be deemed as a finance lease.

The accounts treatment for finance leases is similar to that described for hire and lease purchase contracts, that is, the equipment gets capitalised as a lease asset in the accounts and a deemed loan liability is also set up in the balance sheet. However, the tax treatment is very different, as HM Revenue and Customs (HMRC) tends to follow the legal title in determining the tax relief available. Therefore, finance leases on which legal title will not transfer from the lessor to the lessee would (generally) not allow the lessee to claim any capital allowances on the equipment and would instead allow tax relief to be claimed on the interest element and depreciation charge made in the year by the lessee.

Historically, operating leases have been defined quite simply as those that are not finance lease, which we can take as meaning the risks and rewards of ownership do not substantially transfer from the lessor to the lessee. Operating leases remain off the balance sheet, with neither a fixed asset nor any associated liability appearing in the accounts. Quite simply, the lease charges paid each year would be included as tax allowable expenses in the profit and loss part of the accounts. Contract hire is used commonly by businesses for the provision of cars or equipment and is essentially akin to an operating lease. Note, only an 85 per cent tax deduction of the lease cost for new leases on high emission cars (more than CO₂ 130g/km).

Key considerations

So what are the key considerations in helping decide the best type of finance for you? One of the first has to be defining the financing options that best suit your cash flow position. Some of the payment plans will be more expensive than others, so you need to make sure you choose one that is realistically within your budget and to be aware of what will happen if, for any reason, you fall behind with the contracted payments. For example, a short-term contract hire may prove more expensive per month than a longer term hire purchase, but you would not have the same level of long-term financial commitment.

Your method of finance chosen will have an impact on what your business accounts look like. Hire/ lease purchases and finance leases would increase the value of fixed and lease assets showing in the accounts, but also increase the value of lease (loan) liabilities. Operating lease and contract hire financing would keep both the equipment asset and the related liability out of the balance sheet (known as “off balance sheet financing”), but would increase the annual lease expense going through the profit and loss account, thereby potentially reducing annual net profits showing in the accounts.

Businesses that already have a lot of debt showing on the accounts balance sheet might be keen to avoid adding any more there, which could make “off balance sheet financing” more attractive, as it avoids increasing the gearing of the business. However, any such financing agreements ought to be separately disclosed in the accounts, to help ensure the accounts provide a fuller picture of the financial position of the business.

Possibly the key determinant for many veterinary professionals is the impact on tax relief of the different methods of finance available. Hire and lease purchase has the benefit of the whole capital value of the business equipment potentially being claimed for capital and annual investment allowances. With the annual investment allowance set at £500,000 from April 2014 to December 31, 2015 (reducing to £25,000 from January 1, 2016) this means full capital tax relief can be claimed for businesses on qualifying fixed asset expenditure of up to £500,000 up to December 31, 2015.

In the case of lease and hire purchase contracts, this means you can potentially claim full tax relief immediately on equipment which, due to the hire/lease contract, you will have only partially paid for. This can potentially significantly help your business’ short-term cash flow position.

Finance leases, operating leases and contract hire financing tend to attract tax relief from HMRC based on the payments actually made to the lessor during the year, thereby reflecting the legal title (ownership) of the equipment and not necessarily the argued “substance” of the transaction as showing in the business accounts. This means tax relief is spread more evenly over the life of the lease or hire, which may seem fairer, but many veterinary professionals would rather receive the tax relief immediately, as they would do with most lease and hire purchase agreements.

I have not touched on the VAT status of the different types of lease finance and this will also need to be factored into any decision, with the general rule being that lease payments are normally subject to VAT, apart from the separately identifiable finance charge element relating to hire and lease purchase agreements.

Conclusion

If your head is spinning having reached this point, I must tell you what has been discussed so far is very much a simplification of the rules for lease financing. Therefore, it is important you consult your accountant or financial advisor before making a final decision on what type of finance to choose.

Hybrid leases tend to be available, which seem to contain elements of the different types of leases and so a quick referral to your advisor can help you avoid unwanted disappointments, particularly with regards to claimable tax relief.