There are many factors which need to be
considered when determining fleet acquisition methodology. A number of these will be
commercial, such as choice of vehicles, administration arrangements, etc. Others will be
financial, covering matters such as vehicle acquisition costs, related financing and tax
issues.

One area which is sometimes forgotten when
considering the various alternatives is VAT. Since 1995, the VAT rules applicable to cars
have become slightly complex. However, as most company cars are used for private purposes
to some extent, the VAT rules applicable to the majority of fleets will be as follows:

Acquisition Method VAT Treatment for Fleet User
Contract hire or lease hire 50% of VAT recoverable
Outright purchase, contract
purchase or lease purchase
No VAT recovery

On first sight, contract and lease hire
appears to be the most VAT efficient acquisition method. This is because there is no
financing costs associated with VAT (there is no VAT cost to the hire/lease company) and
only 50% of the VAT on the hire charges is irrecoverable. However, this simple analysis
ignores the possibility of in-house leasing which is available to fleet users which
outright purchase, contract purchase or lease purchase their cars. In-house leasing can
provide the VAT benefits associated with contract and lease hire to businesses which
purchase their fleets.

So what is in-house leasing? Under an
in-house leasing arrangement, instead of purchasing cars, the fleet user will lease the
cars from another group company. That other company will have purchased the cars, ensuring
that, overall, the group will have used its desired acquisition policy.

The following table shows the VAT position
of an in-house leasing arrangement compared to that of a normal purchase arrangement:

 

Normal Purchase Arrangement

In-House Leasing Arrangement

VAT recovery on purchase of
cars

No

Yes

50% restriction on lease
charges

Not
applicable

Yes

VAT chargeable on sale of
cars

No

Yes

In determining whether in-house leasing
will provide any benefits, it is necessary to consider leasing values and residual values
very carefully. The following formula can be used to determine whether in-house leasing
will provide an actual VAT saving:

VAT Saving = (VAT on purchase
price) – (VAT on selling price) – (50% of VAT on lease charges)

However, in addition to any actual VAT
savings which might arise, the benefit of cashflow must also be factored into the
equation. Cashflow benefits arise because the corporate group is able to recover the VAT
payable on the initial purchase of the car, thereby reducing financing costs.

The following table compares the savings
which arise purely from VAT as a result of using an in-house leasing arrangement to
purchase cars and a “normal” purchase arrangement. The table uses the following
source data:

Number of cars purchased – 100
Cost of each car – £15,000 (including VAT)
“Contract” period – 4 years
Anticipated residual value after 4 years – £3,750 (including VAT)
Interest rate – 8½%
Inflation rate – 2½%
Annual in-house lease charge – £3,725 plus VAT

 

In-House Leasing Arrangement

“Normal” Purchase

VAT cost of car purchases

Nil

£223,404

VAT cost of in-house leasing
charge

£130,375

Nil

VAT cost on sale of cars

£55,851

Nil

Cashflow benefits

(£43,500)

Nil

Effect of inflation on
cashflow

(£5,450)

Nil

VAT cost

£137,276

£223,404

By using the in-house leasing arrangement
in this example, the fleet user saves over £86,000.

The benefits available through using an
in-house leasing arrangement will vary depending on the “contract” period, the
level of depreciation and the cost of money to the fleet user business.

Given that the benefits of in-house leasing
arise from VAT, it is worth considering whether Customs & Excise are likely to change
any legislation to prevent it being used. It is difficult to know whether Customs &
Excise do consider in-house leasing as the sort of planning which effects the Revenue
yield. Legislation already in place appear to give tacit approval to this type of
arrangement as it makes specific provisions for ensuring that the value of the lease
between the two group companies is at market value. Failure to apply a market value will
result in the group leasing company being unable to recover VAT on the purchase of the
cars and the whole arrangement becoming worthless. Given that in-house leasing has now
been available for nearly four years, and Customs & Excise have been aware of it from
the outset, it must be assumed that they are content with the arrangement.

Before deciding that in-house leasing
should or should not be adopted, there are a number of other factors which must also be
considered. These relate to direct taxation and include rate of tax applicable to the
fleet user, capital allowances and expensive car leasing disallowance. All of these will
have a direct impact on the VAT benefits which can be achieved. Unfortunately the
combination of factors make it impossible to consider the full effects here. However, it
is likely that, if tax is being paid, expensive car leasing disallowance will be the key
factor in deciding whether in-house leasing is worthwhile.

Expensive car leasing disallowance is the
amount paid in respect of a car lease which is not available for tax relief. Normally a
business purchasing its cars would not need to consider this disallowance, but in an
in-house leasing arrangement, the lease which is created between the group companies can
give rise to the disallowance.

Expensive car leasing disallowance applies
to expensive cars only. Unfortunately, the Inland Revenue defines such cars as those with
a retail price of over £12,000. The effect of expensive car leasing disallowance is that,
depending on the rate of tax applicable, in-house leasing is not worthwhile for cars
costing more than £17,000. This is because the VAT benefits which arise are eroded by the
additional direct tax payable as a result of the disallowance.

In summary, in-house leasing can provide
those fleet users, who have decided to purchase their cars, with an additional VAT
benefit. The administration costs of the arrangement can be relatively small with the
result that tangible and sizeable savings can be achieved. However, the application of VAT
and direct tax can be complex and needs to be carefully considered to ensure that savings
are available. As always, the benefits are there for those fleet managers prepared to do
their homework.

Kevin Ahern, Partner, Deloitte & Touche