Step 4 Assess the tax position

It’s important to determine whether a funding method is tax efficient for the business.

Companies should consider tax elements such as NI, VAT recovery, corporation tax recovery, and capital allowances.

One of the reasons contract hire is one of the most popular funding methods is the advantages it offers in terms of VAT.

In a contract hire agreement VAT will be added to the monthly rental but a company will be able to reclaim 100% if the vehicle is used only for business or 50% if there is any private use of the vehicle.

The VAT on the maintenance and repair services included in contract hire is fully recoverable.

If a company buys its vehicles no VAT can be reclaimed unless the vehicle is used wholly for business.

“For most normal tax-paying companies contract hire has an advantage,” says David Rawlings, director of fleet consultancy firm Business Car Finance (BCF) Wessex.

Of course, tax will vary by company.

Some are exempt or partially exempt from VAT, for example, and corporation tax will not apply to some.

Contract purchase may be more suitable if VAT recovery is restricted, according to Ian Hughes, commercial director at Zenith.

It is also important to look at future tax changes or any changes in legislation or regulations which may impact on the funding method in one or two years’ time.

Lesley Slater, brand director at LeasePlan, says: “With this year’s Budget having clarified the changes to leased vehicle finance and taxation for the coming years, forward planning can now be established within a clear set of parameters.”

Step 5 access to funding

A company’s ability to obtain credit and the price of that credit is important in the overall funding position.

Companies that outright purchase often favour this method because they are cash-rich.

However, buying vehicles ties up money until they are sold and that money may be better invested elsewhere.

“A big mistake companies make when they look at outright purchase is that they don’t think about the cost of depriving themselves of that capital,” Rawlings says.

Graham adds: “Unless you are cash-rich and have no obvious need for the cash and no shareholders that you need to give cash to, why use money on a non-core asset?”

However, he acknowledges that if a company’s internal rate of return is low (say 2-3%), it may be better buying vehicles than leasing.

Many companies don’t accurately calculate their internal rate of return or confuse it with the interest rate on funding – it is crucial to get this aspect right.

Sale and leaseback is a get-out for companies that have bought their vehicles but then need a cash injection.

As the name suggests, the vehicles are sold to a leasing company and then leased back to the customer.

In a similar vein, rental companies such as Northgate also offer ‘sale and rentback’.

Step 6 Company attitude

A company’s attitude to risk and a preference for having vehicles on or off the balance sheet will have a strong bearing on the funding method.

Contract hire and Employee Car Ownership (ECO) schemes are ‘off balance sheet’ while other forms of leasing (such as finance lease and contract purchase) and outright purchase are ‘on balance sheet’.

Balance sheet leasing methods are appropriate for a business that would benefit from the cash advantages of leasing but is ‘asset light’.

Companies that are risk adverse are likely to favour contract hire as the residual value sits with the leasing company that owns the vehicle.

However, some companies are comfortable taking the risk and argue that outright purchase gives them the flexibility to buy and sell a vehicle when it suits them.

Down says a company needs to weigh up whether it wants “complete control” of vehicles or whether it wants “more certainty on running costs” which is offered by a fixed contract/lease.

Bear in mind that contract hire does not provide complete budgeting certainty as the agreement includes charges for early termination, vehicle damage and excess mileage and steps should be taken to avoid or mitigate these.