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Contract Hire (popular with VAT registered companies)
Risk
The Funder assumes risk
Market Share
Around 40% and growing. Popular with all fleets able to reclaim VAT.
How it works
The leasing company calculates a residual value for a vehicle at a set age and mileage contract and charges the user a monthly fee to cover depreciation over that period, plus a funding charge, along with add-on services such as maintenance and accident management. The user takes no risk in ownership and has predictable monthly costs. The user effectively just pays for the use of the vehicle.
Summary
The major beneficiary of the August 1995 VAT rule changes. Set to steal volumes from Hire Purchase in particular, but also Contract Purchase. Overall, a convenient and hassle free funding method - especially if you opt for a full maintenance package.
Hire Purchase
Risk
You assume risk
Market Share
25%. Popular with smaller companies running fewer than 10 cars. The traditional method for smaller companies who are sued to dealing with retail sector. Cash is provided by a dedicated Finance House. The repayment profile is typically an initial deposit of 20% followed by equal monthly installments to repay capital cost of vehicle plus funding.
Advantages
Cashflow: payment by installments
Writing down allowances apply
Interest element allowed against tax
An alternative funding line to Bank overdrafts
Attracts fixed rate interest
Disadvantages
Inflexible: difficult to escape the outstanding statement if, say, a vehicle is no longer needed
High deposit compared with Contract Hire
Appears as a debt on the balance sheet which could inhibit future borrowing
Can be more expensive than Contract Hire due to 1995 VAT charges
Burden of controlling and running the fleet
Summary
Traditional option which is losing ground. A major casualty after the August 1995 VAT changes, because it does not have any significant advantages - unless being used to purchase pool cars - while Contract Hire is becoming more popular.
Risk
You assume risk Market Share around 20%. Popular with 1000 vehicle+ fleets. Typically cash-rich companies in such areas as banking and finance, pharmaceuticals and manufacturing. Vehicles are financed from deposits or loans. The operator takes the risk of maintenance, repair and disposal values, but can give day to day responsibilities to a fleet management company for a fixed monthly fee.
Advantages
Perceived flexibility: vehicles are bought and sold as needed, without fear of penalty charges
Low funding costs: if cash comes from deposits
Writing down allowances: 25% of the capital cost of the vehicle can be offset against tax\each year upto a maximum of £3000 per annum
Vehicles are on balance sheet
Disadvantages
Cashflow: significant front end costs may divert money away from being invested in the Company. There is a minimum opportunity cost - what the money might be expected to earn if invested - of around 8%
Exposure: the fleet becomes vulnerable to residual value variations and exceptional maintenance costs. This method of funding needs high calibre expertise to manage well.
VAT only recoverable if vehicles are used 100% for business
Summary
Popular with large organisations which can enjoy economies of scale and spread the risk over a large number of vehicles. However, less than 5% of fleets with fewer than 50 vehicles buy outright and that is likely to decrease in future as purchasing loses ground to Contract Hire.
Finance Lease (ideal for VAT registered companies)
Finance Lease is similar to Contract Hire in that you are able to reclaim a proportion of the VAT, however you assume the risk of any balloon that you may decide to have at the end of the lease. Although you can never own the vehicle, if, after you have fully paid all payments, including any balloon payment, you may continue to use the vehicle indefinitely by paying a nominal annual fee (?100 approx.) to the leasing company (Peppercorn Rental).
Risk
The Funder assumes risk.
Market Share
Market Share 5% and growing. Popular with companies as an alternative to Contract Hire.
How It Works
The crucial difference from Contract Hire is that Finance Lease rentals are not necessarily dependent on a predetermined vehicle life cycle - and hence residual value. The leasee may pay back the entire capital cost of the vehicle plus changes over a period of time, or may agree a balloon payment to reduce the monthly rental - but never takes ownership. This method is particularly useful for fleets with wide variations in operating requirements. Despite the fact the operator does not assume ownership, he does take residual value risk.
Advantages
Small upfront deposit and the option of a balloon payment
Rentals can be offset against tax
User can decide when to cancel contract but will incur some early termination charges
Disadvantages
Vehicles are on balance sheet
Risk of vehicle resale value lies with user
No capital allowances for user
Summary
Following the VAT changes in August 1995, leasing companies are able to reclaim input VAT which reduces their capital cost and hence the amount of funding and repayments required. This makes Finance Lease a cost effective alternative to Contract Hire for certain companies.
Risk
You assume risk.
Market Share
Around 5% or less. Popular with fast growing small businesses who cannot afford upfront business costs. Contrary to its name, this is not a lease but a purchase scheme similar to Hire Purchase but with an inverted payment profile: a lump sum being paid at the end of the vehicle's life as a final 'balloon' payment.
Advantages
Cashflow: smaller front-end deposit and lower monthly charges ease the initial repayment burden
Investment: allows more cash to be pumped into the business early on, and is therefore attractive for companies with high startup costs.
Others same as 'Outright Purchase'
Disadvantages
The business must be in a healthy shape at the end of the vehicle's fleet life to pay the balloon, which may exceed the vehicle's residual value.
Exposure: the fleet may become vulnerable to residual value decreases and exceptional maintenance costs. You will need high calibre expertise to manage this method of acquisition effectively.
Budgeting: it is difficult to provide robust forecasts with this level of risk.
VAT not recoverable unless 100% business use.
Summary
Useful for companies with high initial startup costs, as it delays the repayment burden until later in the vehicle's operating cycle. Steadily losing ground to Contract Hire, particularly since the tax charges in August 1995.
Small upfront deposit and the option of a balloon payment
Rentals can be offset against tax
User can decide when to cancel contract but will incur some early termination charges
Vehicles are on balance sheet
Risk of vehicle resale value lies with user
No capital allowances for user
Cashflow: smaller front-end deposit and lower monthly charges ease the initial repayment burden
Investment: allows more cash to be pumped into the business early on, and is therefore attractive for companies with high startup costs.
Others same as 'Outright Purchase'
The business must be in a healthy shape at the end of the vehicle's fleet life to pay the balloon, which may exceed the vehicle's residual value.
Exposure: the fleet may become vulnerable to residual value decreases and exceptional maintenance costs. You will need high calibre expertise to manage this method of acquisition effectively.
Budgeting: it is difficult to provide robust forecasts with this level of risk.
VAT not recoverable unless 100% business use.
Lease Purchase - Ideal for non-VAT registered companies
For non-VAT registered companies who want eventual ownership of the vehicle, the company acquires ownership when all the payments have been made. Lease purchase is a form of Hire purchase and part where of the capital cost can be deferred until the end of the contract. The “Balloon” deferred Payment should equate to the anticipated re-sale of the vehicle when the contract finishes.
Benefits:
Fixed monthly payments
Outright ownership on payment of “Balloon” deferred payment
“Balloon” payment reduces your monthly rentals
Greater flexibility at the end of the contract
100% of sale proceeds go to the customer.
Enhanced Benefits for Business Users:
Additional Credit-line
Repayments do not attract Vat
Shown as an asset on Balance Sheet
Writing down tax allowance applies
Interest charges are tax deductible as a business expense.
Disadvantages:
You are responsible for the residual value risk, should the “Balloon” payment be set to high.
Personal Contract Hire (PCH) – Opt-Out of a company car
Personal Contract Hire has been designed especially for people leaving a company car scheme or joining a new company that provides a car allowance instead of a company car.
To qualify for Personal Contract Hire you must provide the finance company with one of the following:
(1) A letter from your company stating the individual doesn’t have access to a company car and is paid an allowance.
(2) A letter stating there is no company car scheme available and the individual will be paid a car allowance.
Advantages
New and Used vehicles qualify
No Vat
Includes Road fund licence for whole term
Optional full maintenance package for hassle free motoring
Personal Contract Purchase (PCP) – For private Individuals
Risk
The Funder assumes risk
Market Share
Up to 5%. Popular with companies seeking to Contract Hire vehicles costing around ?20,000 or more; often used for executive and Director's cars or companies unable to reclaim the VAT portion of Contract Hire because they are VAT exempt. A development of Hire Purchase, Contract Purchase is the only way for Companies to buy vehicles without assuming any residual value risk. It involves a leasing company guaranteeing that the vehicle will achieve a pre-agreed value on disposal at the end of the contract.
How It Works
The risk in the purchase is eliminated and monthly payments cover depreciation over a set period plus a funding charge, giving similar cashflow benefits to Contract Hire. The only difference in the payment cycle is that under Contract Purchase, the user pays the leasing Company a lump sum at the end - and gets a cheque for the same amount back in the next post. This is a technical transfer of ownership.
Advantages
Combines the tax advantages of Outright Purchase, with the cashflow & operational benefits of Contract Hire.
Can also incorporate a service agreement to include maintenance, temporary vehicles & accident management.
Disadvantages
VAT is not recoverable unless the vehicle is for 100% business use.
Summary
The fact leasing companies will be able to reclaim input VAT on Contract Hire cars significantly increases the threshold at which Contract Purchase becomes more tax efficient. Nevertheless, this can be a useful acquisition method for vehicles over £20,000.
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