Finance lease
Similar to contract hire, a finance lease allows the lessee to hire a vehicle for a fixed monthly fee. One of the main differences is that the risks and rewards of ownership of the vehicle are transferred to the lessee.
A finance leased vehicle will show on the lessee’s balance sheet; outstanding rentals will be represented as a liability. Generally, a finance lease will follow one of two standard formats – the residual value lease or the fully amortised lease.
Residual Value Lease – the declining value of the vehicle is exhibited in the monthly rental, with a final balloon payment covering the estimated residual value at the end of the finance period. The lessee acts as a sales agent for the leasing company and sells the vehicle. If the sold price is above the pre-determined balloon payment, then the leasing company will generally refund a percentage of the proceeds to the lessee. If the sold price is below the balloon payment, then the lessee will be liable to pay the shortfall to the leasing company.
Fully amortised lease – the full value of the vehicle is taken into account and there is no balloon rental to consider at the end of the term. The lessee can still sell the vehicle and take a percentage of the proceeds of the sale as above.
When the end of the primary lease period is reached, the customer can request to lease the vehicle for a secondary period at a nominal ‘peppercorn’ rental. If the finance lease is a residual value lease, the lessee must pay the balloon payment before entering the secondary rental period. With the fully amortised lease, the lessee can enter into the secondary rental period immediately.
Some finance companies will provide maintained finance lease contracts, of which the lessee will be able to reclaim 100% of the VAT.
Pros
- Fixed monthly rentals
- 50% of VAT can be reclaimed on the finance element
- Rentals are usually Corporation Tax deductible
- Potential to carry on using the vehicle at the end of the primary lease period
- Additional line of finance that may not affect core banking arrangements
- Car appears as an asset on company books
Cons
- Risk of fluctuations in the used car market
- Monthly rentals appear as a liability on balance sheet