Understanding the tax implications of asset finance – what businesses need to know

Asset finance can be a valuable tool for businesses looking to acquire essential equipment, vehicles, or machinery without having significant upfront cost. While asset finance can improve cash flow and support growth, it is important for businesses to understand the tax implications associated with this type of funding.

There are several forms of asset finance, each with different tax implications. Let’s explore the most popular options:

Hire Purchase (HP) – businesses can acquire an asset by making regular payments over time. At the end of the agreement, the asset has been fully paid and ownership transfers to the business.

Tax implications:

• The asset becomes part of the business’s balance sheet from the outset.
• Businesses can claim capital allowances, including the annual investment allowance (AIA), enabling them to deduct the cost from taxable profits.
• Interest on payments can be deducted as a business expense.
• For VAT registered businesses, upfront VAT payment is reclaimable, the VAT re-payment to the lender can be deferred for up to 3 months, easing cashflow. 

Finance Lease – a finance lease allows a business to use an asset for a fixed period while making rental payments, but ownership remains with the lender. At the end of the agreement the asset is returned.

Tax implications:

1. Payments are typically tax-deductible expenses.
2. As the business doesn’t own the asset, they can’t claim capital allowances on the equipment itself.
3. This is ideal for businesses needing immediate cost relief​​, but not requiring to own the asset eventually.
4. VAT is payable on each lease payment, which VAT-registered businesses may reclaim.

Operating Lease – similar to finance lease but they are typically shorter-term and do not cover the full cost of the asset.

Tax implications:

• Monthly payments are treated as operating expenses and fully deductible for tax purposes.
• The asset is not included in the business’s balance sheet.
• VAT-registered businesses can reclaim VAT on lease payments.

Capital allowances & tax relief

Businesses using asset finance can benefit from various capital allowances, 2 of the most popular are:

• Annual investment allowance (AIA): businesses can deduct the full cost of qualifying assets (up to a set limit) from taxable profits in the year of purchase.
• Writing down allowance (WDA): for assets that exceed AIA limits, businesses can claim WDA to spread tax relief over multiple years.

VAT considerations

There are a number of different VAT options depending on the type of asset finance chosen:

• Hire purchase – VAT is paid upfront on the full asset cost. Option to defer the VAT payment to the lender for up to 3 months to coincide with the businesses VAT return.
• Finance and operating leases – VAT is applied to each lease payment, which VAT-registered businesses may reclaim.
• Leasing – can improve VAT cash flow as payments are spread over time.

Choosing the right asset finance option

When selecting an asset finance option, businesses should consider:

• Tax efficiency – What is preferable out of capital allowances or tax-deductible lease payments?
• Cash flow impact: What is better, an upfront VAT cost of hire purchase versus the spread-out VAT payments in leasing?
• Ownership requirements: What is the best option, should the business choose to own the asset or simply use it for a set period?

Having the ability to understand the tax implications of asset finance is essential for businesses to make informed financial decisions. Choosing the right asset finance option can provide tax benefits, enhance cash flow, and support long-term growth.

For help please consult with our business finance team, we can help businesses maximise tax efficiencies while acquiring the necessary assets for continued growth. To find out more please call us on 01993 706403 or e-mail enquiries@ngifinance.co.uk.