When it comes to acquiring assets for business use, companies often explore various leasing options as an alternative to purchase products. Two common types of leases in the commercial world are finance lease and contract hire. While both options provide access to assets without the need for significant upfront capital, they differ in terms of structure, ownership, and financial implications. Understanding the disparities between finance lease and contract hire is essential for businesses aiming to make informed decisions regarding their asset acquisitions.
What is a Finance Lease?
A finance lease serves as a method of financing, wherein a leasing company (the lessor or owner) acquires an asset on behalf of the user (often called the hirer or lessee) and leases it for an agreed-upon period. As per Statement of Standard Accounting Practice 21, a finance lease is one that transfers “substantially all of the risks and rewards of ownership of the asset to the lessee.”
In essence, the lessee assumes a position similar to owning the asset, with the lessor charging rent as compensation for leasing it. While the lessor retains ownership, the lessee has exclusive use, subject to the lease terms.
Finance lease is a popular agreement for businesses needing cars, vans and commercial vehicles where contract hire is not suitable. It offers flexibility and tax advantages to eligible companies who require one or more vehicles but don’t have the accessible funds to pay for them up front. If your business is VAT registered, you can reclaim between 50% and 100% of the VAT payments depending on whether you are renting a car or commercial vehicle. If your company is not VAT registered, you can choose to spread the VAT costs across the term of the lease by incorporating it into your monthly rental payments.
What happens at the end of a finance lease contract?
The lessee makes rental payments during the primary lease period, which may include a balloon payment. At the end of the contract one option is to refinance the balloon, thorough a peppercorn payment (secondary lease period). Another option is to simply act as a sales agent on behalf of the lessor and sell the vehicle, pay the balloon if there is one and then any sales proceeds will be the lessees to keep. Generally, 99% of sales proceeds will go to the lessee but this will be documented in the contract. Any losses made against a potential balloon payment will be the lessees responsibility and the asset will never be owned by the lessee.
What is Contract Hire?
Contract hire is a leasing agreement where the lessor retains ownership of the asset throughout the lease term. Contract hire arrangements are typically shorter in duration compared to finance leases and are commonly used for assets with shorter useful lives or those subject to rapid technological advancements.
The lessor retains ownership of the asset for the duration of the lease, and the lessee does not assume the risks and rewards associated with ownership. From an accounting perspective, contract hires are often treated as off-balance sheet items for the lessee. This means that the leased assets and associated liabilities are not recorded on the lessee’s balance sheet, which can impact financial ratios and metrics.
Contract hire agreements typically include provisions for maintenance and repairs to be carried out by the lessor or a designated third party. This relieves the lessee of the burden of managing these aspects of asset ownership.
What happens at the end of a contract hire agreement?
At the end of a contract hire agreement, the lessee usually has the option to return the leased asset to the lessor or extend the lease term.
Choosing Between the Two:
While both finance lease and contract hire provide businesses with access to assets without the need for significant upfront capital, several key differences distinguish the two leasing options:
- Accounting Treatment: Finance leases are recorded as assets and liabilities on the lessee’s balance sheet, while contract hires are often treated as off-balance sheet items.
- Maintenance and Repairs: Taking out maintenance is a possibility for both contract hire and finance lease. With contract hire, however, you will be responsible for returning the vehicle in an acceptable condition, (sources such as the BVRLA offer sound advice on what is and isn’t chargeable.) We would recommend getting the vehicle inspected prior to the end of lease and repairing any damages at an approved repairer to avoid any nasty surprises and charges.
- Mileage – One of the main disadvantages of contract leases is that they offer you less control over managing your vehicle. For instance, there’s a set mileage limit. If you go over this, you could end up paying excess mileage penalties, although the price per mile over the limit is discussed at the beginning of the contract, meaning there shouldn’t be a surprise charge. With finance lease, there are no end of contract charges for damages or excess mileage, as it will just reflect against the sale value.
- End-of-Term Options: Finance leases doesn’t include options for the lessee to purchase the asset at the end of the lease term. They can sell the asset and make a profit verses the balloon payment. Contract hire agreements typically offer options to return the asset or extend the lease.
By understanding the differences between these leasing arrangements, businesses can make informed decisions that align with their operational and financial objectives. We offer flexible and affordable car leasing solutions for both personal and business customers. We can supply everything from eco-friendly hybrids to high-performance sports cars by any finance method so our team of experts are sure to find your perfect vehicle at the right price. Whether you’re looking to lease a car or upgrade your company fleet, we’ll guide you every step of the way.