Hire purchase vs leasing: ownership, VAT and tax compared

The British Business Bank puts it simply: the principal difference between leasing and hire purchase is who owns the asset. Under a lease, the leasing company keeps ownership and you pay to use it. Under hire purchase, you pay a deposit and instalments and own the asset at the end, either automatically or by paying a small final fee.

Leasing itself comes in two main forms. A finance lease usually runs for most of the asset's working life and you pay for most of its cost. An operating lease, called contract hire for vehicles, covers only part of the asset's life, so you do not pay its full cost and can upgrade more often. Our guide to finance leases and operating leases compares those two in depth.

With hire purchase, the British Business Bank says that when the agreement ends you will either own the asset or have the option to buy it with a final payment. Until then, the finance company owns it and can take it back if you stop paying.

With a lease, the leasing company keeps ownership throughout. It may offer an option to buy at the end, but the British Business Bank notes that this is not typically automatic. At the end of a lease, it says, you may be able to continue renting, return the equipment or possibly replace it.

HMRC's VAT guidance treats them differently because of ownership. Where title will pass in the normal course of events, which is the usual hire purchase case with a small option fee, there is a supply of goods at the outset. VAT is charged on the price of the asset at the start.

Where the customer is not expected to take ownership, such as when the option payment equals or exceeds the asset's expected market value, HMRC says the supply is one of leasing services and the whole of each instalment is subject to VAT.

• Hire purchase. You pay the full VAT on day one, often with the deposit, and a VAT-registered business may be able to reclaim it under the normal rules. Some lenders, such as Investec, offer to defer VAT on hire purchase so it does not hit cash flow at once.
• Leasing. VAT is spread across the rentals, so there is no large VAT bill at the start.
• Cars. HMRC's notice on motoring expenses says you cannot normally recover 50% of the VAT on leasing a car for business. On buying a car, it says you generally cannot recover the VAT unless the car is used only for business, with no private use available.

Vans and other commercial vehicles are treated differently from cars for VAT. Our guide to van finance covers them.

Neither is better in every case, because the relief comes in a different form:

• Hire purchase. GOV.UK says that when you start using an item bought on hire purchase, you can claim capital allowances for all the payments you will make under the contract, but not the interest. Most plant and machinery can use the Annual Investment Allowance, which is £1 million a year, so relief on the full cost may come in the first year. HMRC's manual says the hire element of a hire purchase agreement is deductible from profits, while the capital part is not.
• Leasing. GOV.UK lists things you lease as not counting for capital allowances, unless you have a hire purchase contract or a long funding lease, because you must own them. Lease rentals are instead a running cost of the business.

So hire purchase can bring relief forward to the year you start using the asset, while leasing spreads it with the rentals. Which suits you depends on your profits, how you account for the asset and the rules for your type of business. Our guide to capital allowances explains the allowances, and you should check the treatment with your accountant before you sign.

Investec Asset Finance, for example, says on its FAQs that a minimum-term lease continues until you give one month's written notice, a fixed-term lease ends with the equipment being returned, and hire purchase ends with full ownership once all payments including the option to purchase fee are made. Read your own agreement, because terms vary by lender.

The British Business Bank suggests some rules of thumb: the longer you need the asset, the more attractive hire purchase becomes, while assets that lose value quickly, or that you will want to upgrade often, tend to suit leasing.

Both are forms of asset finance, and our guide to what hire purchase is covers how an agreement is set up, the deposit and the regulated cases. For vehicles, see contract hire.

Capzy is a credit broker, paid by the lender. We introduce businesses to asset finance providers offering hire purchase and leasing whose criteria fit the asset and the business. You can check your eligibility with a soft search that does not affect your credit score. A lender's full application will usually include a credit check, and any offer is subject to status and lender criteria. Capzy does not give tax or accounting advice. Our types of finance guides cover the other ways to fund equipment.