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NEW TAX RULES FROM APRIL 2009 MAKE LEASING THE WAY FORWARD
Until 1995 most companies opted to purchase company cars. The radical changes to VAT rules relating to leased vehicles introduced at that time triggered an exodus into leasing. However, the VAT recovery advantage is balanced against the Expensive Car Leasing Disallowance (ECLD), a restriction on the amount of tax relief that can be obtained on rentals for cars with a retail price exceeding £12,000. It has been widely believed since 1995 that the tipping point for where purchasing becomes more favourable than leasing is when the price of a car exceeds approximately £20,000, for an ordinary trading company. This may be the case for deferred purchase, but not necessarily so for outright purchase.
Outright purchase is like borrowing from company funds; there is a borrowing rate, a cost of funds associated with it. Leasing is effectively borrowing from a third party. When we choose a mortgage the aim is to go for the cheapest rate, which is exactly what happens here. Our fleet modelling software shows that the higher the company’s cost of funds (the greater the return on each pound invested in the business) the more likely it is that leasing is a more cost effective option than outright purchase, outweighing the disadvantage of the ECLD. The tipping point is actually a cost of funds rate rather than a price of car and this is different for each company.
The 2008 Budget announced fundamental changes to the way corporation tax relief will be claimed for the depreciation of cars (capital allowances) depending on CO2 emission levels, with 110g/km and 160g/km becoming the key levels. Also from 2009, the ECLD will be scrapped to be replaced by a new flat rate leasing disallowance of 15% affecting only those cars emitting 161g/km and above. So how are these changes likely to impact on the lease or buy decision?
THE EMISSIONS INCENTIVE
A company’s costs are likely to be affected whether it buys or leases cars. Lessors, who buy cars to lease on, may look to pass those additional costs on in higher rentals. Therefore, the cost of ignoring these changes could be substantial.
The removal of the £3,000 per annum cap on capital allowances has an interesting effect. For a car priced at £30,000 in the 20% pool (111-160g/km), the first year capital allowance will be £6,000, double what it is currently. In the second year it will be £4,800, again higher than currently. The company would probably recover less relief over the car’s life on the fleet, but it recovers a higher amount sooner. In the context of a mortgage, this is similar to paying large chunks off early, reducing the total amount of interest to pay and reducing the cost of the loan overall. In tandem to that, the removal of the rental disallowance currently based on price could potentially lead to efficient, high residual, high value cars costing less going forwards than they do now.
Similarly, a car priced at £50,000 in the 10% pool (over 160g/km) will have a first year capital allowance of £5,000 and £4,500 in the second year, a less significant cash flow advantage to those cars above, but still useful. In addition, these high-end value cars which currently have a large rental restriction based on price will have only a flat rate of 15% going forwards. The demise of these cars from fleet has been widely predicted, but it may not necessarily be so.
Cheaper cars in the 10% pool could suffer from both the capital allowances deferral effect, manifested in increased rentals, and the fact that where currently there may not be much of a rental restriction because of their low price, there would be the flat rate of 15%. These cars may become unattractive to the fleet market, which is presumably the intention.
LEASING IS MORE ATTRACTIVE
The abolition of a rental disallowance for cars emitting sub 161g/km, means most companies will be better off leasing these cars. For any car emitting over 160g/km it is likely that leasing is again the most cost effective method, unless the company has a very low cost of funds.
Until leasing companies release their post April 2009 pricing, and residual values settle down in these uncertain times, it is difficult to predict for certain but from a purely financial standpoint it looks as if leasing could become the dominant method of funding for most cars.
We always advise companies to include all funding costs in the whole life cost calculations, using discounted cash flow techniques available in our software to calculate the true after tax cost of the car. The way to a perfect fleet is certainly not about finding the cheapest prices on the internet.