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UK Car Leasing Advice

To help you work out which package is the best for you, HM Customs and Excise recognize only two types of funding;

  • A Purchase agreement is where the customer has the right to obtain legal title to the vehicle. (Supply of Goods)
  • A Hire agreement is where the customer has no option to gain legal title to the goods. (Supply of Services)

The following will give you a brief explanation of the different funding options we offer.  We recommend that before you make your final selection that you discuss the matter with your accountant to ensure that you are selecting the correct package for your individual needs.  At the end of this section we have prepared a quick reference matrix to allow to the different compare funding options.

Contract Hire (Hire Agreement)

Contract Hire is simply a method of hiring motor vehicles for use over an agreed time and mileage without ownership, the monthly rental is fixed (often referred to as an Operating Lease).  This can include a range of additional services such as servicing, maintenance, tyres and road fund licence .  This method of funding is a popular choice for VAT Registered companies, with more than 40% choosing this method.  The term of the contract can range from 12 to 48 months and usually up to 120,000 miles.

What are the Benefits?
  • Off balance sheet funding
  • Consistent and accurate budgeting
  • Improved cash flow
  • Fixed interest rates
  • Fixed cost maintenance available
  • Low initial outlay
  • Minimum capital expenditure
  • VAT Recoverable on monthly rentals (1)
  • No depreciation risk - underwritten by finance company
  • No disposal risk
  • Reduced administration costs

Rentals allowable against taxable income (2)

(1) You can only claim 50% of the VAT on the Finance element if you are using the car for private use, 100% if it is business use only (e.g. Pool car).  All the VAT is recoverable on the Maintenance element as this is a business expense.

(2) If the List price of your vehicle is more than £12,000.00 the amount that can be allowed against tax is reduced, if it is less 100% can be allowed, this is called the half excess rule, see example below:

Invoice Price + £12,000.00 / 2 x Invoice Price / 100 = % tax allowable

Finance Lease (Hire agreement)

A Finance Lease is a product for VAT registered companies who prefer a flexible rental agreement, the ownership stays with the finance company but you bear at least 90% of the residual risk or reward at the end of the agreement.

For your tax purposes, a finance lease is a contract where the car is hired, and there is no pre-planned opportunity to purchase the car. The title of the goods, like contract hire, can never be passed onto your company.  The agreement shows on the balance sheet as a leased asset with a corresponding liability. 

There are two types of Finance Lease generally available to you.  The first is a Residual Value Lease, this provides fixed monthly payments over the period of the contract followed by a 'balloon payment'.  The second is a 'fully Amortised Lease', on this type of lease the monthly payments account for the entire value of the vehicle over the contract period.

What are the benefits?
  • Improved cash flow
  • Consistent and accurate budgeting
  • Fixed interest rates
  • Low initial outlay
  • Minimum capital expenditure
  • VAT Recoverable on monthly rentals (1 - As above)
  • Reduced administration costs
  • Rentals allowable against taxable income (2 - As above)
  • Vehicles shown on the balance sheet
  • Opportunity for a third party to buy the vehicle at the end of contract
Business Contract Purchase (Purchase agreement)

This funding method combines the fixed prices and operational benefits of contract hire, however it allows you to own the vehicle at the end of the term at a pre-determined payment (balloon payment).  The balloon payment is set to represent the residual value of the vehicle based on the mileage and term length stated.  If you do not want to purchase the vehicle at the end of most contracts you can hand it back to finance company and have no further cost as long as it is within the mileage and condition terms.

The vehicle will appear on your balance sheet as an asset and is suitable for high value vehicles over £12,000 as it avoids the whole question of restricted tax recovery that are found on Hire agreements.

  • Improved cash flow
  • Consistent and accurate budgeting
  • Capital allowances available
  • Fixed interest rates
  • Low initial outlay
  • Minimum capital expenditure
  • No VAT on finance repayment
  • Reduced administration costs
  • No risk for depreciation
  • No vehicle disposal issues at end of contract
  • Vehicles shown on the balance sheet
  • Opportunity to buy the vehicle at the end of contract

Hire and Lease Purchase (Purchase agreement)

This is the traditional method of funding a new vehicle, it is a straight forward finance agreement where title passes to you when all payments have been made.  The purchase VAT can not be reclaimed unless your vehicle is being used for 100% business use.  After you have paid an initial payment (deposit), the balance of the purchase price, plus charges are repaid over a fixed period by fixed monthly payments.  Unlike Hire Purchase, Lease Purchase has a balloon payment that is set to represent the anticipated value of the vehicle at the end of the term.  With both of these agreements, the risk of resale value, repairs and maintenance lies with you. 

What are the benefits?
  • You gain ownership of the vehicle
  • The vehicle appears on your balance sheet as an asset
  • You claim the write down allowance
  • No VAT on monthly payments
  • Minimum capital expenditure
  • VAT Can be recovered on purchase price if vehicle is used for business purposes only
  • VAT Can be recovered on the running costs

Personal Contract Hire (Hire agreement)

Personal contract hire is a new product that has been designed for you if you are opting out of a company car scheme and have a company car allowance or just want fixed cost motoring.  PCH is a budget friendly alternative to traditional funding methods such as a personal loan or hire purchase.  You can get your vehicle without the need for a large deposit, you simply hire the car for a fixed period and at the end, hand it back to the finance company.

To help you plan your budget further you can include a full maintenance package, this can include servicing, general repairs, tyres and road fund license.  This only leaves you to sort out your insurance and fuel costs.  Please note that if you are using the car for business use you will need to notify your insurance company.

What are the benefits?
  • Consistent and accurate budgeting
  • Low initial outlay
  • Fixed interest rates
  • Fixed cost maintenance available
  • No depreciation risk - underwritten by finance company
  • No disposal risk
  • No final payment
  • Road fund license is often included

Personal Contract Purchase (Purchase agreement)

Personal Contract Purchase or PCP is another flexible way to finance the vehicle of your choice, offering motoring at a fixed cost - so you know, each month, exactly what you are paying.  You can choose the car and the contract that suits your needs.  You decide the type of vehicle you want, how long you want to keep it for and your anticipated mileage.  After this period, you can either pay the pre-agreed 'balloon' payment - which is based on the expected value of the vehicle - and keep the car, or simply hand it back.

What are the benefits?
  • Consistent and accurate budgeting
  • Low initial outlay
  • Fixed interest rates
  • Fixed cost maintenance available
  • No depreciation risk - underwritten by finance company
  • No disposal risk - option to hand car back at end of term
  • Ownership at end of contract if required
  • Road fund license is often included
  • Used vehicles are available on this scheme

 The information provided is for guidance only. We recommend that you seek professional advice from your accountant and tax office before making a decision based on the information given.

Inland Revenue has a guide to personal and company taxation which will be helpful to you.

Disclaimer: No legal liability is accepted for the information given is as it has been provided for illustration purposes only and is correct to the best of our knowledge at the time of publication. It is your responsibility to check the validity of this information and the latest version with the relevant authorities.

Glossary of Terms

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Advertising fee
A fee that an car dealer charges an car buyer to pay for advertising costs.
 
Amortization
Amortization is the gradual reduction of loan principal that occurs as you make periodic loan payments. Generally, the loan principal is completely amortized with the final payment. As you pay back the loan, an increasing amount of each payment is applied to principal and a lesser amount is applied to interest. Amortization is also a process of spreading a cost that is incurred upfront over the term of the loan or life of the asset.
 
Annual percentage rate (APR)
The real cost that you pay to borrow, stated as a yearly percentage of the loan amount. This is sometimes called your effective borrowing cost. For car and mortgage loans, closing costs and discount points are added to calculate APR. For example, if you pay £500 in closing costs to obtain a £10,000 loan, the APR will be higher than the interest rate since you are effectively borrowing £9,500 but will owe £10,000. The Financial Services Act OFT APR CALCULATION requires the lender to disclose the APR to you. For credit cards, the annual fee is often not included in the APR calculation. As a result, an APR of a credit card is often its simple interest rate.
 
Appraisal
Appraisal is the process of estimating fair market value of an asset. Appraisals are routinely required for real estate transactions. An appraiser should be a certified professional. He or she should be an independent party to the transaction in order to avoid potential conflict of interest. Real estate appraisers use methods that are common in local practice. Comparable-sales method is widely used to appraise real estate.
 
Average yearly cost
The average yearly cost of owning a vehicle includes depreciation, operating expenses, and financing charges. Depreciation is the yearly charge that reduces the book value of a vehicle (and your trade-in value). Operating expenses include maintenance, fuel and related expenses. Financing expenses includes the interest paid on an car loan or lease.
 
Balloon Payment
This is the final end payment, usually on a lease purchase or Personal Contract Purchase. It is used to get lower monthly payments as you are not paying off all the value of the car. The value is set based on the mileage per annum you choose.
 
Base price
Price of a car that includes standard equipment, basic warranty and delivery charges but excludes optional features. Base price is printed on the Dealer sticker.
 
BIK
Benefit in kind is the term used by the Inland Revenue to assess the tax liability you have on a company benefit such as car or fuel allowance.  If a company car is provided by an employer the employee is required to pay tax on it's value.  From April 2002 this is calculated using the P11D value of the vehicle, the CO2 rating of the vehicle and the tax band of the employee (23% or 40%).
 
Capitalized cost
Car leasing term that is synonymous with the sale price of the Car.
 
Capitalized cost reduction
Car leasing term that is synonymous with the down payment you make on a new car loan, or the trade-in value that you receive.
 
Closed-end lease
A closed-end lease is a lease that establishes residual value of the leased vehicle and any future fees at the beginning of the lease term.
 
CO2
This is the emission rating of a vehicle expressed as grammes per km. In general the lower the emissions the more environmentally friendly the car is and therefore the lower the tax liability to the driver.
 
Collision insurance
Insurance that pays for damage to your car sustained in a collision.
 
Comprehensive insurance
Insurance that pays for damage your car sustains in an event other than a collision (e.g., theft, vandalism).
 
Cost-benefit analysis
An analysis that compares the cheaper of a) borrowing money to buy a car and paying the interest, with b), paying cash for a car, and losing the opportunity to earn a rate of return on the savings applied to the purchase.
 
Dealer charges
Amounts charged for features sold separately by car dealers, such as rust-proofing, undercoating or services offered in extended warranties.
 
Dealer holdback
An allowance that Carmakers give dealers that is worth about two to three percent of an Car's MSRP. A holdback allowance allows a dealer to pay the maker an amount less than the invoice. This allows the dealer to record a profit by suggesting he paid invoice price for the car when, in fact, he has paid less.
 
Dealer incentives
Programs offered by carmakers to boost sales of less popular models and reduce inventories. Dealers decide whether to pass the savings to customers.
 
Dealer invoice
Amount that carmakers charge dealers for vehicles, including options.
 
Dealer sticker price
The Dealer sticker price plus a suggested markup for dealer-installed options.
 
Depreciation
Depreciation is the systematic reduction of book value over time due to wear and tear and obsolescence. Some equipment types depreciate faster than others. If a piece of equipment has a high book value, it suggests that its depreciation rate is lower than one vehicle with low book value. Depreciation is also used to calculate the residual value of leased equipment. Depreciation expense is a non-cash expense that creates tax savings.
 
Destination charge
A fee not marked-up by the dealer that is paid by the consumer for shipping and dealer-delivery costs of an Car.
 
Disallowable/Allowable   VAT
If a vehicle is funded using Contract Hire or A Finance Lease and is used for personal use, the company can only claim back half the VAT on the rental payment.  The portion of VAT you can't claim back is the disallowable VAT. All the VAT can be claimed back on the maintenance of the vehicle.
 
Down payment
A down payment is the cash you deposit towards the purchase of a home, business property, or vehicle. The larger the down payment, the less you need to borrow. For home loans, a down payment of 20% of the home purchase price is generally required to avoid private mortgage insurance. The value of a trade-in vehicle is often used instead of a down payment for purchasing a vehicle.
 
Early Termination
This is when you cancel a finance agreement before it is due.  Contract Hire agreements are for a fixed term and incur heavy charges for cancellation. Hire purchase, personal contract purchase and lease purchase are much more flexible and easier to settle.
 
Effective rental
This is the actual cost of a rental which takes into consideration the disallowable VAT element of a Contract Hire or Finance Lease agreement. Ie on a rental of £100 plus VAT ie £117.50 total inc VAT you could reclaim half the VAT leaving the effective rental at £108.75.
 
Escrow
The process of using a third party to handle the exchange of funds between buyer and seller in a real estate transaction. The escrow company is a fiduciary. Some states may use attorneys in lieu of escrow companies. Funds are deposited in an escrow account that neither the buyer nor seller can access. The escrow agent ensures that buyer and seller pay appropriate funds at loan closing.
 
Excess mileage
Certain finance agreements have an excess mileage charge.  This is expressed as PPM (Pence Per Mile) and is charged when your vehicle exceeds the agreed mileage.  This can be 'pooled' when multiple agreements are taken out.  For example, 2000 miles over at the end of the agreement at 10p per mile = £200.00 excess mileage charge for you to pay.
 
Final Payment (see balloon payment)
 
Gap protection
IInsurance that covers the amount owed due to early termination of a lease agreement. Such early termination may occur when a car is stolen or seriously damaged in an accident. However, the car insurer's payment may not be enough to pay off the lease balance and any early-termination penalties.
 
Gross income
The IRS defines gross income as all income that is not exempt from tax. It may be received as money, goods, property, or services.
 
Guaranteed Minimum Final Value
This is an agreed value that is found at the end certain finance agreements, typically personal contract purchase agreements. It means that you do not have to worry about the residual value in the future.  The figure is agreed taking into consideration the length of agreement and the quoted total mileage.
 
Home equity line of credit
A home-equity line of credit is a form of revolving credit. This means you can borrow an amount up to but not exceeding a pre-approved credit limit. A home-equity line of credit is secured by the residual equity in your home. To calculate equity, subtract mortgage debt from your home value. Home equity lines allow a homeowner to make repairs or other home improvements, refinance other debt, or use for general purposes. Unlike a home-equity loan, payments are flexible and may consist of interest-only payments.
 
Home equity loan
A home equity loan is a mortgage loan that is secured by the residual equity in your home. To calculate equity, subtract mortgage debt from your home value. Home equity loans allow a homeowner to make repairs or other home improvements, refinance other debt, or use for general purposes. Unlike a home-equity line of credit, a home equity loan is an amortizing loan.
 
Imported Vehicles (Parallel /Grey)
Parallel imports are vehicles that have been imported to the UK from Europe to the UK Specification or similar, Grey imports are none UK models, often imported from Japan etc.  The warranty and final specifications of these cars will be different to a UK model and the residual values will be less. ( please note, we do not sell this type of vehicle)
 
Initial Payment / Rental
This is the first payment you make on an agreement before the car is delivered, like a deposit.
 
Interest rate
Interest rate is the cost of borrowing money as a yearly percentage. For investors, interest rate is the rate earned on an investment as a yearly percentage. The simple interest rate is interest paid or received divided by loan or deposit. For example, £100 in annual interest on a £1,000 loan or deposit is a simple interest rate of 10%. Compounded interest rate is determined by the frequency of interest payments during the loan or deposit term. For example, a 10% loan or deposit that is compounded quarterly equals a compounded rate of 10.38%. If compounded daily, the compounded interest rate increases to 10.52%. (For CD investors, compounded interest rate is called annual percentage yield.) Effective interest rate, or annual percentage rate (APR), is the true interest cost of borrowing. It includes fees and points you pay for a loan in the calculation. As a result, effective interest rate is higher than simple interest rate.
 
Interest rate adjustments
Interest rate adjustment is the amount of change, in basis points, that the base interest rate on a variable-rate loan changes. The interest rate is usually adjusted once a year, on the adjustment date, to reflect changes in the base rate. There are one hundred basis points in one percentage point. The interest rate on a variable-rate loan is the sum of a base, or index, rate and a spread to reflect the credit risk of the borrower.
 
Interest rate lock
Also called a rate lock, an interest rate lock is a temporary guarantee that the interest rate that a lender quotes you will not change. It protects you from the chance of an increase in your borrowing interest rate. Lenders may charge you a small fee to give you an interest rate lock. Although rate locks are usually for 30 days, a lender may be willing to offer a longer period in exchange for a larger fee.
 
Invoice price
The carmaker's base charge to a dealer, which includes a freight charge (often called a destination or delivery charge).
 
Liability insurance
Protects a policyholder when he or she is responsible for personal injury or property damage.
 
Lien
A lien is a legal claim held by a creditor against an asset to guarantee or secure repayment of the debt. Mortgage liens are regularly used in real estate lending as collateral for a loan.
 
Loan application
A preliminary step in obtaining a loan. A loan application tells the lender how much the applicant wishes to borrow and how the loan proceeds will be used; lists personal income and assets; describes work history; and authorizes the lender to receive a credit report to assist in making a lending decision.
 
Loan-to-value ratio
Homes: Loan-to-value ratio is a key factor in determining how much of a home you can qualify for. To calculate, divide the mortgage loan amount by the fair market of the home value. A recent appraisal is generally required to determine fair market value. If you have existing mortgage debt or are adding debt, divide the combined mortgage balance by the home value. For example, a mortgage loan of £150,000 on a home that is appraised at £200,000 has an LTV of 75%. As a general rule, mortgage loans that exceed an LTV of 80% require private mortgage insurance.
 
Manufacturer's rebate
A money-back program that Car makers offer consumers directly to boost sales of less popular models and to reduce inventories.
 
Money factor
Money factor is a leasing industry term that is synonymous with interest rate.
 
Dealer sticker price
Label affixed to the window of an car that discloses the Car's base price, installed options, MSRP, freight charge, and fuel economy (mileage).
 
MSRP
Acronym for Manufacturer's Suggested Retail Price, which is an Car's recommended selling price. Most options are not included in the MSRP.
 
Off Balance Sheet
If a vehicle is funded on Contract hire for example, it does not show as an asset on the company's balance sheet. It shows as a cost in the profit and loss account, therefore offering a tax saving in most circumstances. Please seek professional advice on this subject from an accountant.
 
Open-end lease
A lease term that requires the lessee to pay the difference between residual value and fair market value at the end of the lease term if the fair market value is lower.
 

OTR

On The Road price, this is the final invoice value of the vehicle, including road tax and delivery to the dealer. Contract hire agreements do not have an on the road price as you are only in effect renting the car from the owner (the finance company)
 
P11D Value
As a company car driver you are responsible for paying income tax on your benefit.  The is the amount that that the Inland Revenue use to work out your taxable benefit.  The value is calculated by adding the list price and any extras (both dealer fitted and factory fitted) together but excludes the Road Fund License and First Registration Fee (£25.00).
 
PPM
Pence per mile - If you have an agreed mileage amount on your contract, any excess will be charged by the mile.
 
Preparation charges
Charges imposed by a dealer for preparing a newly purchased car for delivery to the buyer. These include fueling and servicing the car and any cosmetic changes made just prior to sale.
 
Pooled Mileage Agreement
As a business running a large fleet you may wish to group or Pool the mileage of your cars.  This helps keep the over all running costs down, for example one driver may do 10,000 miles under the agreed amount, another may do 10,000 miles over.  If pre-arranged with the finance company you could stop any further charges by netting one of against the other.
 
Reconditioning reserve
An car leasing term synonymous with security deposit. The lessee gives the lessor a reconditioning reserve in the event a leased Car's condition deteriorates to a point where reconditioning is necessary.
 
Reduced Spread (Spread Rental)
This is how most contract hire agreements are marketed, it is a way of keeping the monthly payment down to a minimum.  For example a three year Reduced Spread would be shown as a '3+35', making a total of 38 payments.
 
Residual value
Residual value is the value of a leased vehicle or other equipment at the end of the lease term. Residual value is the fair market value of the leased equipment. It is the price the lessee pays to buy the equipment if they exercise the purchase option.
 
Revolving credit
Revolving credit is a type of open-end credit. Open-end credit allows the borrower to borrow funds from the loan as long as it does not exceed the credit limit of the borrower. In some cases, lenders require minimum payments or impose a clean-up period. These steps ensure that the borrower continues to have the means of repaying the debt.
 
RFL
This stands for Road Fund License, or road tax as it is commonly know as.
 
Savings interest rate
The savings interest rate is the yearly interest rate you earn on your savings. It is also used to calculate the opportunity cost of paying with cash. In contrast, the saving rate is the percentage of income you save.
 
Tax savings
Tax savings are the amount you may save in taxes from a tax deduction or credit that you would otherwise pay if you did not have the deduction or credit. Tax savings are also called a tax shield. To calculate tax savings from a deduction, multiply the amount of the deduction by your marginal income tax rate. At an income tax rate of 25%, a £2,000 qualified contribution to a company retirement plan may save you £500 in taxes. And if you paid £10,000 in home mortgage interest, you may save up to £2,500 in income taxes if you are in the same tax bracket. Your deduction for interest expense on mortgage and home equity debt may be limited. You may wish to consult a financial or tax adviser. For businesses, tax savings are realized on such deductible expenses as lease payments, interest on loan payments, and depreciation expense.
 
Term
The period of a loan, generally measured in years. Car loans: generally range between two and five years. Mortgage loans: generally 15 or 30 years.
 
Terminal Pause (Terminal Rental)
This refers to a payment profile for your contract or agreement such as '3+33' or '3+21'.  Basically, the two amounts add up to the period of the agreement, and because you pay two extra payments up front, you have a two month payment free period at the end.  This allows you to allocate funds for your next '3' advance payments when you change your car.
 
Title
A legal document that shows who owns an asset. A title includes any liens or other encumbrances, which are claims on the asset by lenders.
 
Trade-in value
A dealer assigns a trade-in value to an Car, boat or other vehicle that a buyer wishes to exchange for a replacement vehicle. Trade-in value, also called trade-in allowance, is subtracted from the purchase price of the vehicle. Trade-in value is often based on the published book value of the vehicle. As a general rule, a vehicle with less wear and tear has greater trade-in value.
 
Underwriting
Underwriting means different things to different financial-services industries. For mortgage lenders, it is the process of evaluating a loan prospect to see if they have the financial capacity to repay the loan. For investment bankers, it is the process of arranging a sale of stocks or bonds to investors. For insurance companies, it is the process of calculating a premium for a specific pool of insurees with certain risk characteristics such as age or health.
 
Upfront costs
Upfront costs are fees and any other costs that you pay at a loan closing. This includes mortgage loans, as well as consumer and installment loans, such as home equity, refinancing, personal or car loans. Upfront costs are also called closing costs. Upfront costs include the amount needed for a down payment, any prepaid interest, loan underwriting fees, and fees that you pay for ancillary services. These include fees for title search, appraisal and credit report.
 
Upside-down
A situation in which the fair value of an car is less than the principal balance of your car loan. This often happens because of the large depreciation in the car from excess due to excess wear and tear during the early years of a car loan term.
 
VAT Qualifying Vehicle
IIf for example a vehicle is purchased by a contract hire and leasing company for the sole purpose of renting it out to a customer, the vehicle is classified as a VAT qualifying vehicle.  The purchaser of the vehicle claims the VAT back and when they sell it at the end of its life with them, it is value is plus VAT.  This is common on six month old cars that are being re-marketed on contract hire.
 
Vehicle options
Vehicle options are choices that are sold separately for an extra fee when you buy a vehicle. Options increase the vehicle sale price.
 

 

 

 

 


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