Finance Lease is possibly the oldest and simplest form of externally funding vehicle purchases. This ‘on balance sheet’ lease structure leaves you and your company to carry the risks and rewards of ownership (i.e. Residual Value risk).
Questions you may have:
How does it work?
In simple terms it puts you in much the same position as if you had purchased the vehicle outright. It does not therefore provide certainty of cost, but to some companies the appetite for risk is sufficient. By retaining all risks and rewards associated with residual value of the vehicle, you would have no restrictions on the period of lease and can change the lease period typically without incurring any penalty charges.
With a Finance Lease the full cost of the Capital is repaid by you, with any sales proceeds being refunded in the form of a rebate of rentals. The repayment of capital can be scheduled in a fashion to meet your cash flow requirements which is very flexible. Contracts can either be fully amortised (paid down to zero) over the contract length, or payments can be structured in such a way that a balloon (or final payment) is due at the end of the contract and this obligation can be offset against the sales proceeds of the vehicle to neutralise cash flow implications.
IFRS 16 Update : For Publicly quoted firms that report to the International Financial Reporting Standards and the public sector
New lease accounting rules effective from 1 January 2019.
The International Accounting Standards Board (IASB) has now published a new International Financial Reporting Standard (IFRS) 16, which requires lessees (customers leasing an asset) to recognise assets and liabilities for most leases on the balance sheet. IFRS 16 will supersede the current lease standard International Accounting Standard (IAS) 17.
Previously, a lessee would have to determine whether the lease is a finance lease or an operating lease. This is effectively done by assessing the risks and rewards inherent in the lease. Contract hire arrangements are usually operating leases.
Publicly listed companies already have to make a note to the annual report, which reflects any operating lease rentals payable. Businesses will need to ensure they report on their liabilities (rental payment arising under the lease) and their asset (the right to use the leased asset).
The cost of financing the vehicle is spread over the contract period, cashflow is improved as no large capital outlay (as with outright purchase) is required.
Cost Of Finance
Due to the fact that the leasing provider is not carrying the Residual Value risk, Finance Lease generally attracts a lower cost of financing premium than Contract Hire.
Monthly rentals are typically fixed for the duration of the contract, however a balancing charge or credit is made at the end of the lease when the actual sale of the vehicle has taken place. This end of lease adjustment will mean that budgeting is less predictable than contract hire for you.
Greater flexibility re period of ownership - no contractual restrictions re period of time / mileage for which the vehicle can be used.
VAT Recovery - Up to 50% of the input VAT on the finance charge and 100% of the input VAT on any associated services or maintenance costs can be recovered. For vehicles that are used solely for business purposes with no private use whatsoever then up to 100% of the input VAT on the finance charge is recoverable. For vans 100% of the input VAT can be recovered on both the finance charge and services / maintenance charges and this will not vary by financing method. The actual VAT recovery position will also be dependant on the VAT status of your organisation.
Leasing cars can offer a method of car provision that is more cost effective than direct purchase arrangements. No input VAT is recoverable on cars purchased outright or via a form of purchase lease/ hire arrangement where the organisation takes ownership or has an option to take ownership of the car.
Residual Value Risk
Residual Value Risk - Risk and reward associated with the value of the vehicle at the end of the contract is retained by you, note you are not protected from any adverse movements in the used vehicle market.
Tax Deductible Expense
If your organisation is in a tax paying position you are allowed to deduct finance rentals against profits in order to gain corporation tax relief.Under the corporation tax rules introduced in April 2013, you can deduct the full cost of finance rentals from taxable profits if the car emits 130g/km of CO2 or less; or 85% of the finance rental on vehicles with higher CO2 emissions. For all vehicle acquisition methods vehicle ancillary services and maintenance expenditures are fully allowable for corporation tax relief.
Vehicle Management and Administration
These are not typically included in the finance lease rental but can be added as additional services to give you the peace of mind that all services are covered.
Early Termination Costs
Not applicable with finance lease agreements, however as under these contracts the risk and reward is retained by the lessee, any changes to the original forecast contract duration will be reflected in the balancing rental charge between the written down value of the vehicle and the sale proceeds.
Excess Mileage and Damage Charges
Not applicable with finance lease agreements, however as under these contracts the risk and reward is retained by the lessee, the actual sale proceeds will reflect changes to the original budgeted mileage and if the actual condition of the vehicle is below market standard. Therefore the balancing rental charge between the written down value of the vehicle and the sale proceeds will be impacted.
Option To Own The Vehicle
No option to take ownership, however the lease can be extended indefinitely, which dependent on whether you have a balloon at the end of the lease or not will affect the payments you will need to make. Extending the lease could give rise to a continuation of the same rental or a lower secondary rental.
Off Customer Balance Sheet*
Transfers Risk and Reward to Lessor
Utilises 3rd Party Funding
VAT Recovery on Capital - Car 50% (unless exclusive business use), Van 100%
Full VAT Recovery on vehicle services
Capital Allowance Claims by Customer
Lease Rental Restrictions apply
Creates Employee Company Car Benefit in Kind (BIK)