Should I pay cash upfront or in instalments? You’d be amazed how often we hear this question – and as you’d expect there are tax implications.
In these austere times careful financial management is hugely important, especially when it comes to acquiring company equipment. So do we buy, hire or lease?
Will buying an asset outright suit me?
This really is the simplest situation – you pay for your asset outright with cash. However, take the bitter with the sweet here. For instance, you can claim back the VAT on most assets – except cars – though initially the upfront costs can be high. There are other factors to consider too:-
Depreciation: Put simply, an asset’s value will decline over time.
A finance charge (if you have to take out a loan) is normally allowed against tax.
Bought equipment is easier to replace or sell at the owner’s discretion than leased equipment.
The pros and cons of hire purchase
Sometimes an initial upfront cost requires more capital than you can spare. Paying in instalments is a way around this but do bear in mind the interest payments and the nominal fee after your last instalment.
Hire purchase is effectively a form of debt. The creditor is still the owner of the goods until they are fully paid for.
One again, there’s no sunshine without rain. While the initial cost is lower, the interest payments make this more expensive overall.
You won’t own the asset but its value depreciates over time and as far as your accounts are concerned it’s treated as if you did.
You can’t claim the expense against tax and again the asset is treated under Capital Allowance.
Payment instalments are recorded on a balance sheet and payments are apportioned between capital repayment and interest.
What is a finance lease and will it work for me?
A finance lease is similar to hire purchase in that you pay a series of instalments or rentals. You don’t legally own the equipment but you do bear most of the risks and rewards associated with it.
As the customer, you have use of the asset during the period of the lease while paying instalments to the finance company.
Typically, a finance lease has an initial period of fixed length at full cost, followed by a secondary period at a much lower cost.
For example, a risk would be any expenses incurred during use of the asset – for example upkeep or maintenance or if the asset is stolen.
A reward refers to the economic benefits gained from acquiring the asset such as appreciation in residual value or increased revenue by selling goods produced or constructed by the asset.
For accounting purposes, finance-leased assets are treated in the same way as goods on hire purchase.
VAT charged by the finance company is payable on the initial instalment and each subsequent rental.
How does an operating lease work?
This type of lease is very commonly used when someone wants to acquire equipment on a short-term basis. In other words, it’s just renting the equipment.
It’s a popular option and tends to work out cheaper overall.
An operating lease is common where a second-hand market exists. For instance, with cars the lessor leases the vehicle to the lessee for a fixed monthly amount and also assumes the residual value of the vehicle. With cars you can also claim back 50% of the VAT.
The lease period is typically 2-3 years – always less than the working life of the asset.
There are no capital allowances here. VAT is added to each rental instalment so the cost is spread throughout the lease period.
Summing up
Hopefully the lines won’t seem too blurred when it comes to acquiring company equipment and you can decide what works best for you.
To strike it rich in business you have to spend wisely and acquiring equipment is no game of chance – it pays to know the rules.
Still, with a good understanding and careful consideration of the options available you can get more bang for your buck.
Good luck, and as always get in touch if you’d like to discuss any of the issues outlined above – we’d be only too happy to have a free no-obligation chat.
