Finance lease vs hire purchase: which option is best for your business?
We go through how finance leasing and hire purchase work so you can decide what’s best for your business.
Henry Bell
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0
min read
It’s a common dilemma: your business needs essential assets like vehicles, machinery, or equipment to operate and make money – but what if you haven’t got the cash on hand to buy it? That’s why businesses turn to finance agreements that let them get their hands on equipment now, but pay for it later. Two of the most popular choices are finance leasing or hire purchase.
While both can help you spread costs and manage your cash flow, there are key differences between the two which can impact your choice, especially when it comes to ownership and tax implications. So let’s go through how finance leasing and hire purchase work so you can decide what’s best for your business.
What is a finance lease?
In a finance lease, your business pays to use an asset over its useful life, but ownership remains with the leasing company. At the end of the term, you typically have the option to:
- Return the asset.
- Sell it on behalf of the lessor (often with a rebate).
- Enter a low-cost extension period, known as a "peppercorn rental".
Key features that you need to remember include:
- Ownership: Remains with the leasing company.
- Payments: Regular rentals, which may include an initial higher payment.
- End-of-term options: Sell on behalf of the lessor or extend the lease.
- Tax benefits: Monthly payments are usually tax-deductible.
What is hire purchase?
A hire purchase (HP) agreement enables you to pay for an asset in instalments over time, with ownership transferring to your business once the final payment is made – potentially as a hire purchase balloon payment. This option is beneficial for businesses that want to own the asset eventually but spread the cost.
The key features to know about hire purchase are:
- Ownership: Transfer at the end of the agreement.
- Payments: Initial deposit followed by fixed instalments.
- End-of-term: Full ownership upon final payment.
- VAT treatment: VAT is paid upfront, which can be reclaimed by VAT-registered businesses, providing a useful cash flow boost at the end of the quarter.
Finance lease vs hire purchase: tax treatment and accounting
While both finance leasing and hire purchase involve a payment term, they are treated quite distinctly when it comes to taxes and accounting.
- Finance lease tax treatment: Payments are typically tax-deductible expenses. However, as you don’t own the asset, you can’t claim capital allowances on the equipment itself. This is ideal for businesses needing immediate cost relief, but who don’t mind whether they will own the asset eventually.
- Hire purchase tax treatment: Interest on instalments is deductible, and you can claim capital allowances once you assume ownership. For VAT-registered businesses, upfront VAT payment is reclaimable, which may enhance cash flow.
Accounting for finance lease vs hire purchase
The accounting treatment varies significantly between the two, which will impact how you can manage the costs over the term.
- Finance lease accounting: The asset is recorded on your balance sheet, with regular payments seen as liabilities. Depreciation expenses apply, impacting profit and tax calculations.
- Hire purchase accounting: Treated as an asset acquisition, so payments cover both the capital and interest. The asset is depreciated over its useful life, and interest is treated as an expense.
Pros and cons: is finance lease or hire purchase right for you?
While both options enable you to make use of the asset in question during their term, each option has distinct big-picture benefits and drawbacks depending on your business’s objectives, cash flow, and long-term needs.
Finance lease pros:
- Low initial outlay: Can be great for managing cash flow with smaller upfront costs.
- Tax efficiency: Rentals are generally deductible as business expenses.
- Flexibility: End-of-term options include returning or extending the lease.
- Maintenance: Since you’re not the owner, leasing companies often provide maintenance or replacement options for leased assets.
Finance lease cons:
- No ownership: You don’t build equity in the asset.
- Potential balloon payment: Lower monthly payments may require a larger final payment.
- Depreciation risk: Although you don’t own it, asset devaluation can influence end-of-term decisions, such as potential rebates or the size of the balloon payment relative to the value.
Hire purchase pros:
- Ownership: Can be ideal if you want to keep the asset long-term.
- Capital allowances: Tax advantages from claiming allowances once you assume ownership, where you can write off a portion, or the entirety, of the value on your tax.
- Stability: Fixed monthly payments can help with budgeting.
Hire purchase cons:
- Higher upfront costs: VAT and deposit may require significant initial funds.
- Asset depreciation: You bear the full depreciation cost once you own the asset.
- Liability: Full responsibility for maintenance and repairs during and after the term.
Finance lease vs hire purchase for car financing
If you’re exploring vehicle finance, both finance lease and hire purchase offer distinct benefits.
With finance leases, monthly costs may be more predictable, and you have options for vehicle replacement or upgrading more frequently. However, hire purchase provides outright ownership, allowing for resale or upgrades as business needs evolve.
Choosing the right financing for your business
When you’re planning a long-term commitment, it pays to take the time to understand the nuances between finance lease or hire purchase. By making the most of the distinct structures, tax benefits, and ownership considerations involved, you can maximise the utility of the equipment while you need it, while also looking after your cash position.
Finance leasing may fit businesses looking for flexibility with less upfront cost, while hire purchase is ideal for those aiming to own high-value assets over time. By looking ahead to your strategic needs, financial outlook, and the lifespan of your asset, you can ensure your equipment provides value from the start to the end of your term.
If neither option is appealing to you, then one of our flexible business loans could be an ideal fit for you.
Finance lease vs hire purchase FAQs
Is a finance lease better than a hire purchase?
This depends on your business needs. If you prefer flexibility without ownership, finance leasing may suit you. For long-term assets, hire purchase often provides better value due to ownership transfer.
Can I switch from finance lease to hire purchase?
Switching mid-term is usually not possible due to different structures and tax treatments. That’s why it’s so important to think about your needs carefully to select the best option upfront.
Which option is better for tax relief?
Both offer tax advantages. Finance leases treat payments as deductible expenses, while hire purchase allows capital allowances on owned assets.
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