What are the VAT pros and cons of leasing cars?

May 28th 2024

You are considering leasing instead of purchasing cars for your business. This will improve cash flow and, according to the salesperson, allow you to reclaim VAT that you would not otherwise be entitled to. Is this correct?  Naomi Swan explains the rules.

Generally, VAT paid on the purchase of cars for use in your business (not cars bought for resale) can’t be reclaimed because the rules specifically prevent it. This block applies if there is expectation of any private use of the car, no matter how small. However, there are exceptions to the block.

You can reclaim the VAT if it is to be used by your business as a taxi, driving school vehicle or car hire business. The car must be primarily used for these purposes and minor private use doesn’t prevent the VAT being reclaimed.

However, where a car is used by one or more of your workers, other than in the circumstances described above, there must be a physical or legal restriction preventing private use, e.g. a strictly enforced contract with the worker prohibiting private use.

If you lease instead of purchase a car, you can reclaim all the VAT paid on leasing charges as long as there’s a prohibition on private use and there is no such use. But unlike VAT on car purchases, some VAT can be reclaimed on leasing charges even if there’s private use.

If a car is used for business and private purposes, you can reclaim 50% of the VAT that the leasing company charges you. This rule applies irrespective of the ratio of private to business use. For example, if you or your workers use a car for business, say just 10% of the time and 90% for private journeys, you are still entitled to reclaim 50% of the VAT on the leasing charges.

While the 50% rule applies to all charges relating to the supply of the car, e.g. excess mileage fees, it doesn’t apply to additional services for which the leasing company charges you, e.g. maintenance fees. However, this is only the case for costs that are separately identified on the leasing company’s invoices, and which are optional add-ons. Such charges benefit from another VAT break.

The full amount of VAT paid on repair and maintenance costs for cars used for business, including separately identified maintenance charges for leased cars, can be reclaimed regardless of how much they are used for private journeys.

You can only reclaim 50% of the VAT charged for compulsory additional fees even if they are separately identified on the leasing company’s invoices.

If you or the leasing company terminate the lease early, the leasing company will usually charge a termination fee to which it will add VAT. This is also subject to the 50% rule. Similarly, if you are paid a rebate of rentals at the end of a lease (typically, this happens after the vehicle is sold by or via the leasing company), you must declare 50% of the VAT credit on your return if you were subject to the 50% input tax block on the leasing payments.

Where you lease a car for use in your business and there’s private use (no matter how small), you can reclaim 50% of the VAT you pay on the leasing charges. The good news is that you can reclaim 100% of the VAT for any additional fees, e.g. a maintenance charge, but only if it’s an optional service.

Contact the JRW Hogg & Thorburn team to discuss this further or other VAT and leasing questions you may have.

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