Funding By Cash Or Contract Hire
More businesses than ever now contract hire their company cars instead of paying cash but is the reason just the obvious one. If you don’t have the cash, contract hire.
The answer is more complex and there is no set rule, as individual circumstances mean it is a different decision for everyone. Deciding whether to contract hire or pay cash can either be made on pure intuition or a careful appraisal of the issues involved.
What would make you contract hire instead of paying cash? Let us say you have sufficient cash in the bank to fund all of your company cars if so required.
First of all, contract hire fixes your costs of motoring over the contract period, so if you are the type of organisation who operates tight budgets, this method of funding makes life a lot easier. Company vehicle repairs out of warranty can be very expensive. Full maintenance contract hire removes the possibility of unexpected huge vehicle repair bills blowing your budgets to pieces.
At the same time, contract hire equalises out your motoring costs incurred over the period of the contract. Each month you will be paying some capital cost, some interest, some maintenance etc etc in equal payments. To many businesses, an even cash expenditure on company vehicles is nice, it suits far more, rather than peaks and troughs, especially if the company’s own income is even over the year.
Using contract hire instead of cash conserves your capital. You might have the cash available but you may be able to use it more efficiently in other parts of the business, employ another member of staff, bulk buying of stock etc. It seems a little wasteful to use all your cash just for moving people or goods around.
Another advantage of contract hire over cash is one that it rarely mentioned but is of real value. Running vehicle fleets can create a mass of paperwork, documents, invoices etc. It takes time to deal with all of this. Also, suppliers have to be negotiated with and paid with different payment methods and terms etc.
Contract hire reduces all of this to one direct debit. It eliminates most of the administration costs, stresses and financial risks of vehicle ownership, the removal of these chores are almost enough to justify contract hire on its own.
Then, there is VAT. Normally a business cannot claim back the VAT when it buys a car for cash. It is considered there is always some private use, going home and back, going to the shops etc. HMRC does actually say that if a car is used 100% for business and some enforcement is in place such as clauses in employees’ contracts etc; then, exceptionally, all of the vat on the purchase price of the car can be recovered. However, it is a brave company that goes down this route, the HMRC advice is a little contradictory and the rules are strict.
Organisations such as driving schools, daily rental companies and contract hire companies, can reclaim all of the vat on the purchase price of a new car, cars are their business. The contract hire company is therefore able reclaim the VAT on the car cost and reflect the saving in the rental, so the lessee gets the benefit.
However in the tax world nothing is ever straightforward. The rentals, themselves attract VAT but you cannot claim all of it back. As the lessee, you will only be able to claim 50% of the VAT incurred on the monthly rental if there is any private use of the car (50% is better than nothing).
Some businesses that are exempt or partially exempt for VAT purposes (because they supply VAT-exempt or low VAT rate goods and services such as insurance, finance or training) may only be able to recover a proportion of the 50% of recoverable VAT.
Again, if there is no private use at all, such as a pool car, then 100% of the VAT can be recovered by the lessee.
This 50% block on VAT recovery only applies to the finance element of the rental charge. It does not apply to any of the services in the contract hire agreement, for example, maintenance, for which VAT is fully recoverable, subject to normal partial exemption rules.
Another area where businesses prefer contract hire to cash is when the vehicle has finished its useful life with that business. With contract hire the residual value risk and the chore and costs of disposal are taken on by the contract hire company, leaving the lessee to concentrate on its business.
Advantages of funding by cash:
- Flexibility: the business retains full control of fleet and is not locked into contracts
- Any resale profits (if applicable) at the end of the vehicle’s life will be retained by the business
- Capital allowances available for depreciation element
- VAT on maintenance and repairs can be reclaimed
Disadvantages of funding by cash:
- Unable to reclaim full 20% VAT on purchase price unless it is used solely for business
- Full exposure to residual value risk
- Administration burden lies with the business
- Takes risk for unexpected repair costs
- Ties up capital that could be used elsewhere