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Is car buying through the company more efficient?

11th May 2023
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Your client is the owner manager of a small company. They want to buy a new car. What are the different ways of purchasing it, and is it more tax efficient to buy through the business or pay personally?

image of cars being charged
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The client's car needs

Your client is the sole director shareholder of a company. They have selected three possible vehicles; an electric car with zero emissions, a hybrid with CO2 emissions of 35g/km, and a petrol car with CO2 emissions of 100g/km. All three have a similar list price of around £40,000.

Your client would like to understand the tax implications for each of the various ways to acquire the car, and for the chosen method, whether it would be more tax efficient to buy it through the business or extract the cash from the company and pay for it personally. How should you advise?

Outright purchase

The most straightforward way to purchase the car is an outright cash purchase. If this is done via the company, it will account for the cost of the car as a fixed asset, with the depreciation of the vehicle disallowed for tax purposes but capital allowances are given instead.

Hire purchase

If your client doesn’t want to part with £40,000 in one go, a hire purchase (HP) agreement is a way of acquiring the vehicle without having to pay for it in full on day one. Instead, an upfront deposit is paid followed by monthly payments, with ownership passing on payment of the final instalment. As the car is purchased in instalments, an element of interest is included within the monthly payments which is deductible for corporation tax purposes.

Example. The company enters into a four-year HP agreement paying a deposit of £9,200 followed by 48 monthly payments of £850. An overall cost of £50,000. If your client purchased the car outright it would cost them £40,000. This extra £10,000 is the interest on the loan, which is charged to the profit and loss account across the four years at £2,500 per year.

As an HP agreement is for the purchase of a vehicle, the company will again account for the actual £40,000 cost of the car as a fixed asset, with capital allowances given instead of depreciation.

Finance lease

A finance lease is similar to an HP agreement in that an upfront deposit is paid followed by monthly instalments, and also that the car is recorded as an asset on the balance sheet. However, it differs in one fundamental way: the ownership of the car for tax purposes does not pass to the lessee and therefore capital allowances cannot be claimed, confirmed at CA23805.

This assumes the finance lease is not treated as a long funding lease - broadly a lease for longer than five years.

Therefore as no capital allowances are available, a unique situation arises where the depreciation charged in the accounts is allowable for tax, discussed at BLM00540.

Example. The £40,000 cost of the car is depreciated over the term of the lease, i.e. £10,000 per annum. This £10,000 together with the annual interest charge of £2,500 is charged through the profit and loss account and allowed for tax purposes.

Where a car has CO2 emissions over 50g/km, 15% of the lease payments (both the interest charge and depreciation) is disallowed in the tax computation.

Contract hire

A contract hire agreement is effectively the rental of the car for a short period, where the car is handed back at the end of the term. All payments under the lease go through the profit and loss account and are allowable for tax. The same 15% restriction applies on cars with CO2 emissions over 50g/km. Your client has decided that an outright cash purchase is more straightforward and will prove more cost efficient in the long run. So, what are the tax implications for purchasing through the company compared with buying personally?

Capital allowances

The rate of allowances available to your client will depend on the CO2 emissions of the chosen vehicle. Electric cars with zero emissions will qualify for a first year allowance of 100%, meaning full tax relief in the year of purchase. Cars with CO2 emissions of 1-50g/km will go into the main rate pool and receive writing down allowances of 18%, and cars with CO2 emissions over 50g/km will go into the special rate pool with writing down allowances of 6%.

Only new and unused electric cars receive the 100% first year allowance - second- hand electric cars will go into the main pool.

From a corporation tax point of view, therefore, it will be more tax efficient to acquire the electric vehicle as tax relief for the full value of the car will be received in year one. But what about from an income tax point of view?

Benefit in kind

As your client will be using the car for private purposes a benefit in kind will arise. Again the rate of tax will depend on the CO2 emissions of the car, and in the case of hybrid vehicles it will also depend on the range the car can travel on its electric battery alone. The benefit in kind will be employment income subject to income tax.

Electric cars with zero emissions will be charged at 2% of list price. Hybrid cars can be as low as 2% if their electric range exceeds 130 miles, but as high as 14% if the electric range is less than 30 miles. The hybrid which your client is considering has an electric range of 42 miles and therefore will be charged at 8% of list price. The petrol car with CO2 emissions of 100g/km will be charged at 25% of list price.

Example. With a list price of £40,000, the benefit in kind for the electric car will be £800, the hybrid £3,200, and the petrol car £10,000.

The percentages have been frozen until the 2024/25 tax year, at which point they will rise 1% each year from 6 April 2025 to 5 April 2028.

Given the tax advantages available for electric vehicles, your client has decided to go for the zero-emissions car. How will purchasing through the company be beneficial?

Comparison

In order to demonstrate the net cash benefit of purchasing through the company, let’s assume that the company has £100,000 of taxable profit each year after paying a salary to your client equal to the personal allowance, and that your client extracts all the after-tax profit as a dividend.If your client buys the car personally, they will be left with net cash of £20,691, whereas if the car is bought via the company, your client’s net cash will increase to £40,853.

Example. From April 2023 the corporation tax on £100,000 of profit is £22,750, leaving £77,250 payable as a dividend. The net dividend after tax will be £60,691 and after buying the car your client will be left with £20,691. In contrast, if the company buys the car claiming capital allowances of £40,000, the taxable profit will drop to £60,000 with corporation tax of £12,150, leaving £47,850 payable as a dividend. Your client will have a benefit in kind of £800 in addition to the dividend, but the net income after tax will be £40,853.

Of course, the benefit in kind charge is annual, and tends to increase. For higher emission vehicles the tax charges may eventually eclipse the upfront savings so it’s important to look at the position over several years.

When looking at the upfront tax relief, purchasing outright via the company is likely to be the most efficient option. However, don’t forget that the annual benefit in kind charge for the company car will erode the savings over time. For cars with higher emissions figures, this may mean the company route is more expensive in the long run.

For a special discount on Tax Essentials for Advisors