Choosing the best way to finance a business asset, whether it’s a vehicle or any different kind of machinery, hinges significantly on the intended payment method. For businesses with substantial reserves, an outright purchase might be the go-to option. However, for others, alternatives like hire purchase or leasing contracts might be more feasible.

These choices come with varied tax implications, contingent on the asset type, contract nature, and the accounting basis used — not to mention the additional consideration of VAT for registered businesses. Tax relief for outright purchases is straightforward, granted in the financial year of purchase. But when it comes to other financing methods, the rules tend to diverge.

Understanding Tax Relief

Typically, capital expenditure doesn’t directly reduce taxable profits — this is where capital allowances come in. The exception to this rule is when accounts are prepared on a cash basis, allowing immediate relief against profits unless the asset falls under a disallowed category, like cars. However, with the accruals basis, while a direct deduction for capital expenditure is off the table, capital allowances offer a potential avenue for relief.

The annual investment allowance (AIA) stands at a generous £1 million, providing 100% relief on qualifying plant and machinery expenditure up to this limit (excluding cars). Expenditure beyond this threshold moves into either the 6% or 18% writing down allowance pools, based on the asset type.

Lease Types and Their Implications

Broadly speaking, there are two main lease categories: operating leases and finance leases.

Operating Leases (Hire Purchase): In a hire purchase scenario, the asset is treated much like an outright purchase, reflected in the balance sheet and depreciated annually. The deal usually encompasses a purchase option at the end of the initial term. For accounting purposes, the expenditure is recognized once the asset is in use, despite the legal title transfer only occurring upon final payment. Finance charges, spread across the lease term, are deductible, and any VAT on these charges is payable upfront.

Finance Leases: Here, we differentiate between short-funding and long-funding leases. A short-funding finance lease, typically lasting seven years or less, does not permit the lessee to claim capital allowances as the lessor maintains ownership. Nevertheless, the asset appears on the lessee’s balance sheet, with the payment obligation listed as a liability. Payments are split between finance charges (which are tax deductible) and liability reduction, with VAT reclaimed on each installment.

Conversely, long funding leases, spanning beyond seven years, flip the script, allowing the lessee to claim capital allowances and making them responsible for the asset’s insurance and maintenance.


Navigating the landscape of capital allowances on leased assets requires a careful evaluation of your financing options and their tax implications. Understanding the nuances between different leasing contracts and accounting methods is crucial to optimizing your tax position and ensuring compliance.

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