Full expensing and hire purchase: how the tax relief works

Full expensing and the AIA in brief

Full expensing lets companies deduct 100% of the cost of qualifying new and unused main-rate plant and machinery from their profits in the year they buy it. Special-rate items, such as integral features of a building, get a 50% first-year allowance instead. GOV.UK says the equipment must not be a car, and you can't claim both full expensing and the AIA on the same item.

The AIA gives 100% relief on up to £1 million of qualifying spending a year and is available to sole traders and partnerships as well as companies. It can also cover second-hand equipment, which full expensing can't. For many small businesses, the AIA alone covers everything they spend in a year.

Full expensing excludes plant bought for leasing out to others, apart from certain background plant in buildings. That's why who owns the equipment under your finance agreement matters.

Hire purchase and capital allowances

Under the capital allowances rules for hire purchase, HMRC treats the person hiring the equipment as its owner, as long as they'll become the owner at the end of the agreement. That means you, not the lender, claim the allowances. HMRC's manual says you can claim on the future capital payments as well as those already made once the equipment is brought into use.

GOV.UK's guidance on the AIA says the same thing in plainer terms: if you buy an item on hire purchase, you can claim on all the payments you're due to make when you start using it, but not on the interest. The interest and charges are deducted from profits as a business expense, normally spread over the agreement in line with your accounts.

Some agreements are labelled lease purchase. HMRC says these only count as hire purchase for this purpose if they're accounted for as a finance lease. If you can only buy the equipment at the end for its market value, you aren't treated as the owner until you do.

Our hire purchase page explains how HP agreements work, including deposits and balloon payments. The equipment can be repossessed if you don't keep up repayments.

Leasing and capital allowances

With most finance and operating leases, the finance company stays the legal owner and claims the capital allowances. You normally deduct the lease rentals from your profits instead, broadly as they're charged in your accounts.

There's an exception for some longer leases, known as long funding leases, where the business using the equipment can claim allowances instead of the lender. HMRC also says a business can choose, for some leases, between claiming allowances with a restricted rental deduction or taking the full rental deduction without allowances. These rules are technical, so your accountant should look at the specific agreement.

A simple worked example

This example is simplified and for illustration only. It assumes a profitable limited company buying a new £100,000 main-rate machine and using it straight away.

• On hire purchase: the company can claim full expensing (or the AIA) on the £100,000 in the year it starts using the machine, and deducts the HP interest over the life of the agreement.
• On an operating lease: the company doesn't claim allowances, but deducts the lease rentals over the term. The lender claims the allowances.
• As a sole trader on hire purchase: full expensing isn't available, but the AIA can give the same 100% deduction, as long as there's enough AIA left for the year.

Hire purchase front-loads the tax relief, while leasing spreads it. Neither is automatically better. It depends on your profits, how long you'll keep the equipment, and whether you want to own it at the end.

Selling, refinancing and balancing charges

Claiming 100% upfront has a catch when you sell. HMRC says that if you dispose of equipment you've claimed full expensing on, a balancing charge arises on the disposal value, which adds that amount back to your taxable profits. For special-rate items that got the 50% allowance, the charge is 50% of the disposal value, with the rest coming off the pool. For AIA claims, the disposal value is deducted from the pool, and a balancing charge arises if it's larger than the pool.

This matters for sale and leaseback and some forms of asset refinance, where you sell equipment to a lender and lease or buy it back. The sale may count as a disposal for capital allowances. HMRC also says that where you sell and lease back, you can't claim the AIA or first-year allowances again on the same asset. Ask your accountant before you refinance equipment you've already claimed allowances on.

Our guide on whether you can refinance equipment you already own explains how refinancing works in practice.

VAT on hire purchase and leasing

VAT works differently too. HMRC's VAT guide says hire purchase is treated as a supply of goods, so VAT is normally due on the full value of the equipment at the start, usually through the deposit or first payment. If you're VAT registered and the equipment is for business use, you can normally reclaim that VAT on your next return, subject to the usual rules.

Leases and hire agreements are treated as continuous supplies, so VAT is charged on each rental as it falls due. That can be easier on cash flow at the start. If paying VAT upfront on HP is a concern, it's worth raising when we compare quotes.