When a UK limited company acquires a car for business use, the decision to either lease or buy the vehicle has distinct consequences for the company’s tax position. The treatment for Corporation Tax and Value Added Tax (VAT) is governed by a specific set of rules that depend on factors such as the car’s CO2 emissions, its use for business and private journeys, and whether the company owns the asset or pays rentals.
Leasing a Car Through a Limited Company
Leasing typically involves a contract hire agreement where the company makes regular rental payments for the use of the car, which remains owned by the leasing company (the lessor).
Corporation Tax Relief on Lease Rentals
Lease rental payments are generally treated as a revenue expense and can be deducted from the company’s profits, thereby reducing its Corporation Tax liability. However, a restriction applies to the deduction of hire costs for certain cars.
- Cars with CO2 emissions over 50g/km: For leases entered into from April 2021, if a car’s CO2 emissions exceed 50g/km, a 15% restriction applies. This means only 85% of the car hire costs are allowable as a deduction for Corporation Tax purposes.
- Cars with CO2 emissions of 50g/km or less: If the car’s CO2 emissions are 50g/km or less, 100% of the lease rental payments are deductible against profits, subject to the costs being incurred for business use.
VAT on Lease Rentals
If the company is VAT-registered and leases a ‘qualifying car’ that is used for business purposes, the treatment of VAT on the lease payments is subject to a specific block if the car is available for private use.
- The 50% Input Tax Block: A business leasing a car that is available for any private use cannot normally recover 50% of the VAT charged on the lease rentals. This is known as the ‘50% block’ and acts as a proxy for the tax on private use. The remaining 50% of the VAT can be reclaimed, subject to the normal rules for input tax recovery. This block applies to all charges under the leasing agreement, including optional services unless they are supplied and invoiced separately.
- Exceptions to the 50% Block: A business can reclaim 100% of the VAT on lease charges if the car is a qualifying car and is used primarily for specific qualifying purposes, such as a taxi for carrying passengers or for providing driving instruction. The 50% block also does not apply if a car is hired for no more than 10 days specifically for business purposes, provided it is not a replacement for an ordinary company car.
Ongoing Motoring Costs
VAT incurred on repairs and maintenance can be reclaimed in full as input tax, provided the business paid for the work and the vehicle is used for business purposes. This is the case even if the vehicle is also used for private motoring.
Buying a Car Through a Limited Company
When a company buys a car, it can claim capital allowances to deduct a portion of the vehicle’s value from its profits over time. Cars do not qualify for the Annual Investment Allowance (AIA).
Capital Allowances
The rate of capital allowances a company can claim depends on the car’s CO2 emissions and whether it is new or second-hand. For cars purchased from April 2021 onwards, the following rules apply:
- 100% First-Year Allowance (FYA): A company can deduct the full cost of a new and unused car from its profits in the year of purchase if the car has CO2 emissions of 0g/km (i.e., it is an electric car).
- Writing-Down Allowances (WDA): For other cars, WDAs are claimed annually on the reducing balance of the cost. The expenditure is allocated to one of two pools:
- Main Rate Pool (18% WDA): Expenditure on cars with CO2 emissions of 50g/km or less is allocated to the main rate pool, which has a WDA rate of 18% per annum. This also applies to second-hand electric cars.
- Special Rate Pool (6% WDA): Expenditure on cars with CO2 emissions exceeding 50g/km is allocated to the special rate pool, which has a WDA rate of 6% per annum.
If the balance in either the main or special rate pool is £1,000 or less before calculating WDA for the period, the entire remaining balance can be written off as a small pools allowance.
VAT on Car Purchase
The rules for reclaiming VAT on the purchase of a car are highly restrictive.
- General Rule (100% Input Tax Block): As a general rule, a business cannot recover the VAT on the purchase of a car. This is a complete block on input tax recovery.
- Exceptions to the Block: A business can recover 100% of the VAT on a car purchase only in very specific circumstances, for instance, if the car is:
- To be used exclusively for business purposes and is not available for private use. A “pool car” that is kept at the business premises and not allocated to a single individual typically meets this condition.
- Intended to be used primarily as a taxi, for driving instruction, or for self-drive hire.
- A stock-in-trade vehicle for a motor dealer.
If VAT is recovered in full under one of these exceptions and the car’s use later changes to a non-qualifying purpose (e.g., a pool car is allocated to an employee for private use), the business must account for a “self-supply” and pay output tax based on the car’s value at that time.