tax implications of leasing and buying

As your business grows you will face choices as to how that growth is financed. Mark Chapman, Director of Tax Communications at H&R Block, explains the tax implications of your choices.

In some cases, your business may be sufficiently profitable that future growth plans can be financed from internally generated capital. In most cases, it will be necessary to look to external finance in order to secure the funds your business needs to grow.

Amongst the areas you might be looking to finance are:

The acquisition of new and bigger premises, or an extension to existing premises
The acquisition of new equipment, fixtures and fittings
Taking over competitor businesses through mergers and acquisitions
Development of new product lines

If you borrow money to finance the growth of your business, interest paid on that finance will generally be tax deductible, provided all the borrowed funds are used for business purposes (you’ll need to apportion the interest if some of the finance is used for private or domestic purposes).

Loan payments and tax deductions

Loan payments consist of two elements:

The repayment of the principal, which is a capital expense and not deductible
The interest element (cost of finance), which will be deductible where the loan is for business purposes.

Interest is deductible immediately, even where the borrowed funds are used to acquire capital assets, such as property or plant.

Deductible costs for arranging finance

Costs incurred in arranging a borrowing are also deductible by the business, as are costs incurred in discharging a loan. That might include:

Loan procurement fees
Guarantee fees
Legal costs
Stamp duty
Valuation fees
Survey fees
Underwriter’s fees

No deduction is available if the finance doesn’t go ahead.

Financing asset purchases for the business

In many cases, you’ll want to raise finance to acquire new assets to use in the business, such as fit-out equipment (which could include everything from plant and equipment to shelves and racking to music systems and POS equipment), vans for transporting stock, or new IT systems. In some cases, you’ll borrow money to acquire the asset from a bank or other financial institution (in which case, the borrowings are dealt with as above) and in others, you’ll lease the asset.

There are different ways to lease an asset. The distinctions between buying an asset using hire purchase (HP), taking out a finance lease, and taking out an operating lease can be quite subtle, but the tax treatments—and the legal obligations and responsibilities imposed on your business—can be very different depending on which route you take.

Hire purchase contracts

If your business acquires assets under a hire purchase contract, you will acquire full legal ownership of the assets, subject to any security on the asset put in place by the lender.

For tax purposes, the following deductions for assets financed under an HP contract can be claimed:

The interest component of the HP payments
Repairs
Depreciation on the asset from the date of the HP contract

Finance leases

If your business takes out a finance lease on an asset, your business will take on many of the risks and rewards of ownership of the asset without—initially at least—taking on legal ownership. Typically, after paying the lease payments for the duration of the term, your business will legally acquire the asset by paying out the residual payment to the lessor. Until that point, the entity leasing the asset to your business will be the legal owner.

For tax purposes, lease payments made under a finance lease are immediately deductible. In addition, as your business will be responsible for keeping the asset in good order, any repair or servicing costs will also be tax deductible. Your business can’t claim the depreciation on the asset—the entity leasing the asset to you will claim that.

Operating leases

If your business takes out an operating lease on an asset, it is basically renting that asset from the leasing entity, which retains ownership of the asset.

In many cases, that can be an attractive option. Because the risk of ownership remains with the entity renting the asset to your business, you avoid any of the risks of obsolescence and don’t have to worry about maintaining the asset or repairing it if it breaks down, since the lessor is usually responsible for all those costs.

For tax purposes, payments made under an operating lease are immediately deductible in the period to which they relate, provided the asset being leased is used in the business. As noted above, servicing and repairs will often be included in the headline rental cost, but if charged separately, they will also be deductible.

For expert guidance on tax implications when financing your business growth, H&R Block provides tailored advice to help you navigate your tax obligations efficiently.

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