One of the documents Mr Perrin supplied us with was a page from the website of GRV 4 Fridge Vans. This summarised the differences between acquiring a van:
- on hire purchase, and
- on a finance lease
The same rules apply to other items of plant and machinery such as cars, office equipment, or a combine harvester
You will remember from your Financial Accounting modules that you would generally treat both arrangments as “finance leases”. In both situations the risks and rewards normally associated with ownership lie with with the lessee. For tax purposes, though, the tax treatment is very different.
For accounting purposes you follow the “substance over form” principle. The commercial substance of both types of agreement is identical.
In both cases you would:
- recognise, in the balance sheet, the plant as a non-current asset and the payments due under the finance lease as a liability, and
- deduct, in the P&L account, the finance costs and depreciation.
However, for tax purposes, we have to look at the legal form rather than the commercial substance.
If a van, say, were acquired on a finance lease where ownership of the vehicle was not automatically transferred at the end of the lease, then, for tax purposes, all the payments would be treated as revenue items and no adjustment to the accounting profits would be required. The timing of the deductions would follow the treatment in the accounts. This is an exception to the general rule which would normally require you to add back the depreciation.
On the other hand, the finance agreement could state that ownership of the van would pass to the lessee at the time of the final payment. In this case, for tax purposes, we treat the expenditure on the van as a capital item. The finance costs are still allowable as a revenue dedcution but the cost of the van would qualify for capital allowances instead.
Expenditure on a van would qualify for annual investment allowance. This means that relief could possibly ge given on the full purchase price in the year it is acquired. However, most cars will only qualify for writing down allowances at 8% or 18%, so tax relief will be received much later than under the alternative leasing arrangements
There is one compication with HP contracts that businesses (and their accountants) need to watch out for. The full purchase price can only be brought into the capital allowances pool once the asset has been brought into use. Until then only the deposit and instalments due within 4 months can be claimed . This is only usually a problem if an HP contract is entered into at the end of an accounting period.
For example, a company draws up its accounts to 31 December each year. It enters into an HP contract and pays a deposit on 24 December 2016 but does not take delivery of the machinery until 3 January 2017 . It can treat the deposit and payments made in the following four months as qualifying expenditure in the AP to 31/12/16 but would only be able to claim the balance of the payments in the AP to 31/12/17.