Leasing

What it means

A lease finances the use of an asset: the lessor acquires it and the lessee uses it against instalments. A finance lease points towards ownership passing at the end; an operating lease is in substance a long-term rental with the asset returned.

The difference has direct accounting consequences. Under a finance lease the lessee carries the asset in fixed assets and depreciates it; under an operating lease the instalment is an ordinary cost and the asset stays with the lessor.

Throughout the lease, the leasing company owns the asset, even though under a finance lease the lessee reports it among its own assets. The lessee therefore may not sell or pledge it, and modifying the vehicle or machine needs the lessor’s consent. With a loan it is the other way round: the borrower owns the asset from the start and the bank secures itself with a lien.

How it works in practice

A finance lease instalment splits into principal, finance cost and insurance - only the second and third are expenses. The enlarged first payment is spread across the whole term, not charged to the month of signature.

For vehicles, motor vehicle tax follows business use regardless of how the vehicle is financed. Comparing against a loan, what decides is the total cost of finance, not the monthly instalment.

Under a finance lease with an agreed transfer of ownership, VAT treats the deal as a supply of goods at the moment the asset is handed over. The leasing company charges VAT on the whole price at once, and a VAT payer deducts it in a single period, not in parts alongside the instalments. Under an operating lease, VAT applies to each instalment as to a service.

What to watch out for

Ending a lease early is usually expensive and awkward in the books: unamortised amounts are caught up and the settlement follows a contract clause nobody reads until it is too late. So the termination terms get read before signature.

After a total loss or theft of the vehicle, the lease ends early and the insurer pays the car’s value at the time of the damage, which is usually lower than the balance still owed to the leasing company. The lessee pays the difference out of pocket. For longer contracts it is therefore worth comparing cover for this gap, not only the price of comprehensive insurance.