Hire purchase and leasing both let you use a vehicle or piece of equipment without paying for it all up front. The main difference is ownership. With hire purchase, you own the asset once the final payment is made. With a lease, the finance company owns it and you pay to use it.
That difference changes how tax relief and VAT work. Neither is always better. The right choice depends on the asset, how long you will keep it and your tax position.
How hire purchase works
You usually pay a deposit, then fixed monthly instalments over an agreed term. Some agreements have a larger final balloon payment. Once everything is paid, ownership passes to you.
For tax, the business is treated as buying the asset from the start. It claims capital allowances on the full cost once the asset is brought into use, and the interest is deductible as a finance cost. For vans and equipment, that usually means relief for the full cost in year one through the Annual Investment Allowance of £1m or, for companies buying new, full expensing.
For VAT, the VAT on the full price is normally charged up front and can be reclaimed in one go if you are VAT registered, except on cars, where input VAT is usually blocked.
How leasing works
There are two common types of lease.
Finance lease. You pay rentals that cover most or all of the asset's cost over the lease. You take on most of the risks of ownership, such as maintenance and insurance, but legal title stays with the lessor. At the end, the asset is often sold and you receive most of the proceeds.
Contract hire or operating lease. You pay a fixed rental to use the asset for a set period, often with an agreed mileage limit for vehicles. Maintenance may be included. At the end, you hand it back.
For tax, the rentals are generally deductible as they are charged in the accounts. You do not claim capital allowances, because you do not own the asset. VAT is charged on each rental and can be reclaimed as you go if you are VAT registered.
Cars are different
Two restrictions apply to leased cars:
- If the car's CO2 emissions are over 50g/km, 15 percent of the lease rentals are disallowed for tax.
- Where the car is available for private use, 50 percent of the VAT on the rentals is blocked.
On a purchased car, including one on hire purchase, input VAT is usually blocked entirely, and capital allowances are slower: 14 percent a year for cars up to 50g/km and 6 percent above. New zero-emission cars are an exception, with a 100 percent first-year allowance available until March 2027.
A worked example
A VAT registered company with profits in the 25 percent band needs a new £40,000 van.
Hire purchase. The company reclaims the VAT up front. It claims full expensing on £40,000, saving £10,000 of corporation tax in year one. The interest is deductible over the agreement.
Contract hire at £750 a month plus VAT. The company deducts £9,000 a year and reclaims the VAT on each rental. Over four years, it gets relief on £36,000 of rentals, spread evenly, but never owns the van.
Hire purchase gives faster tax relief. Contract hire gives predictable costs and no worries about resale value.
Other things to weigh up
- How long you will keep it. Assets kept for many years often suit hire purchase. Vehicles you replace every three or four years may suit contract hire.
- Cash flow. Hire purchase often needs a deposit. Leases may need several months' rental up front.
- Selling later. When you sell an asset on which you claimed 100 percent relief, the proceeds are usually taxable.
- Mileage and condition. Contract hire agreements charge for excess mileage and damage at the end.
- Your accounts. Hire purchase and finance leases appear as liabilities on your balance sheet, which lenders will take into account.
- Benefit in kind. If an employee or director uses the vehicle privately, there is a benefit in kind whichever method you use.
What to do
- Get quotes for both hire purchase and leasing on the same asset and term.
- Compare the total cost after tax relief and VAT, not just the monthly payment.
- For cars, check the CO2 emissions before you choose.
- Read the end-of-term terms, including balloon payments, mileage limits and return conditions.
If you would like us to compare the options for a specific purchase, book a free call.
