Hire purchase vs leasing: which suits your company?

The core difference is ownership. With hire purchase, your company pays for the asset in instalments and owns it once the final payment is made. With a lease, your company pays to use the asset for a set period, and the finance company usually keeps ownership throughout.

That single difference drives everything else: how VAT is charged, how the agreement appears in your accounts, who claims tax relief on the asset and what your options are at the end. Both are forms of asset finance, both spread the cost of equipment or vehicles, and in both cases the asset itself acts as the main security.

HMRC's own guidance notes that the economic differences between hire purchase and a finance lease can be limited, because in both cases the user carries most of the risks and rewards of the asset. The practical differences tend to show up in tax, VAT and what happens when the agreement ends.

Hire purchase

The lender buys the asset and hires it to your company. Your company usually pays a deposit, then fixed monthly instalments covering the cost of the asset plus interest. When the final instalment and any small option to purchase fee are paid, ownership passes to your company. Some agreements include a larger final balloon payment, which lowers the monthly instalments but usually raises the total cost.

During the term your company maintains and insures the asset and generally cannot sell it unless the agreement is settled first. Our page on business hire purchase explains the product in more detail.

Finance lease

The lender buys the asset and leases it to your company for most of its working life. Rentals cover the cost of the asset plus interest. Your company maintains and insures the asset, but it does not take ownership. At the end it can usually continue renting, return the asset, or sell it on the lender's behalf, often receiving a share of the sale proceeds as set out in the agreement.

Operating lease

An operating lease covers a shorter period than the asset's useful life. The lender takes the risk on the asset's value at the end and the rentals reflect only part of its cost. Maintenance may be included, and your company hands the asset back or upgrades when the term ends. Contract hire for vehicles works in a similar way. See equipment leasing for how lenders structure these.

On hire purchase, VAT on the asset is usually due at the start, because HMRC generally treats it like an outright sale. On a lease, VAT is charged on each rental, so it is spread across the term.

With hire purchase, the VAT on the full price of the asset is normally payable when the asset is delivered, and many lenders ask for it alongside the deposit. A VAT-registered company can usually reclaim it on its next VAT return, subject to the normal rules, so the outlay is often temporary. The finance charges themselves are usually exempt from VAT, so there is no VAT to pay on the interest.

With leasing, each rental carries VAT, which a VAT-registered company can usually reclaim on the return covering that period. This avoids a large upfront VAT payment, which can help cash flow, particularly for expensive assets.

Special rules apply to some assets, most notably cars, where reclaiming VAT is often restricted. Agreements with a large final payment can also be treated differently depending on how they are structured. Ask your accountant how the rules apply to the specific asset and agreement.

An asset on hire purchase normally appears on your company's balance sheet as a fixed asset, with the amount still owed shown as a liability. Leases have traditionally been treated differently, but that has changed for many companies.

Under older UK accounting rules, operating lease rentals were simply charged to the profit and loss account, with no asset or liability on the balance sheet. Recent amendments to FRS 102 mean that companies reporting under it now bring most leases onto the balance sheet, in a similar way to international standards. The rules for the smallest companies, and the exemptions available, can differ.

This matters if your company has banking covenants, is preparing for a sale or investment, or wants its accounts to look a certain way to lenders. Your accountant can tell you how a lease would be shown under the standard your company uses.

In broad terms, with hire purchase your company is treated as the buyer and can usually claim capital allowances on the asset, while with a lease your company usually deducts the rentals as a business expense. The details depend on your circumstances, so take advice from your accountant before deciding.

HMRC guidance confirms that under hire purchase it is the hirer, not the finance company, that gets the capital allowances on plant and machinery. The capital part of the payments is not deductible as an expense, but may qualify for capital allowances such as the annual investment allowance, which can allow a large part or all of the cost to be deducted in the year of purchase, subject to the rules in force. The interest element is generally deductible from profits over the term.

With a finance or operating lease, the lessor usually claims the capital allowances, and your company typically deducts the rentals from its taxable profits as they fall due. Some longer leases, and leases of cars, follow different rules.

Because the timing of tax relief differs, the right choice can depend on your company's profits, plans and the allowances available in a given year. This is general information, not tax advice.

End of term options are often the deciding factor. Here is how they typically compare:

• Hire purchase: your company pays any final balloon and option fee, then owns the asset outright. It can keep using it, sell it or trade it in.
• Finance lease: your company can usually extend for a secondary period at a reduced rent, return the asset, or sell it on the lender's behalf and receive an agreed share of the proceeds. It does not normally become the owner.
• Operating lease or contract hire: your company returns the asset, extends, or replaces it with a newer model. Charges may apply for excess wear or usage, such as mileage over an agreed limit.

Leasing usually needs less cash at the start, while hire purchase builds towards ownership, so every payment goes towards an asset your company will keep. The right balance depends on your cash position today and how long you plan to keep the asset.

With hire purchase, the upfront outlay can include a deposit plus the VAT on the whole asset, even if the VAT comes back on your next return. Monthly instalments then repay the full cost of the asset plus interest. With a finance lease, there is usually one or more rentals in advance and VAT only on those rentals. With an operating lease, monthly payments can be lower again, because the lender expects to recover part of its cost by selling the asset at the end.

Lower payments are not the same as lower cost. Compare the total payable over the term, what your company will own or receive at the end, and any end of term charges. A lease calculator can help you test different rental and term combinations.

Hire purchase tends to suit assets your company will keep for most of their working life. Leasing tends to suit assets you will replace regularly or that lose value quickly. A simple way to think it through:

• Choose hire purchase if you want to own the asset, expect to use it for many years, want to claim capital allowances and can manage the upfront VAT.
• Choose a finance lease if you want to spread VAT, prefer deducting rentals and do not need to own the asset at the end.
• Choose an operating lease or contract hire if you want to upgrade regularly, avoid the risk of the asset's resale value and, where offered, include maintenance in the payments.

Fleets, plant and specialist equipment can each point different ways. Our pages on vehicle and fleet finance and plant and machinery finance cover those assets. If you are still deciding whether to use asset finance at all, read asset finance vs a bank loan.

Whichever you choose, read the agreement carefully. Lending to limited companies, LLPs and partnerships of four or more partners is usually unregulated, so Consumer Credit Act protections generally do not apply. Points to check:

• The total amount payable, including deposit, fees, balloon and option fees.
• Whether a personal guarantee is required from the directors.
• Early settlement or termination costs.
• Insurance and maintenance obligations, and any usage limits.
• That the asset can be repossessed if payments are missed.

You can test monthly payments using our asset finance calculator.

Welcome Finance is a commercial finance broker, not a lender. We check your company's eligibility in about 60 seconds without affecting its credit score, then introduce you to suitable lenders on our panel offering hire purchase, leasing or both. Lenders run their own credit checks once you decide to apply and make their own decisions.

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