Is leasing a car tax-deductible when you’re self-employed?

Around 5 million of the cars being driven on UK roads are through lease deals, with 92% of new car purchases being made through finance in 2022. The availability of Personal Contract Purchase (PCP) offers, growth in electric vehicles and the rising cost of living have all made it more attractive to hire a car over a fixed period rather than owning it outright.

But should you buy or lease your next car if you’re freelancing or self-employed?

As the “lessee”, you’re taking out a short or long term rental agreement with the provider of the vehicle, known as the “lessor”. You’ll make fixed monthly payments to use a potentially brand-new car, and either hand it back, or own it via Hire Purchase and PCP deals. Contract terms are usually between two and five years. And the main contract options include:

• Personal Contract Hire (PCH) – you make an initial payment followed by monthly amounts for a car which you hand back at the end of the contract. The vehicle can be used for any purpose, including personal and business use.
• Business Contract Hire (BCH) – Essentially the same as PCH, but your business will cover payments and running costs.
• Hire Purchase (HP) – You pay towards owning the vehicle over the term of the agreement
• Personal Contract Purchase (PCP) – After paying an initial deposit, you make monthly payments until the end of your lease contract, when you can choose to make a final “balloon payment” to buy the car, or hand it back.

PCP offers have proved incredibly popular as they provide lower monthly payments than HP deals, but still give you the option to buy the vehicle at the end of the contract, or simply hand it back to the lease provider.

Business Contract Hire is also a common choice for sole traders, partnerships and limited companies as you can avoid paying company car or van tax, whilst also reclaiming both business mileage and rental costs subject to some restrictions based on vehicle CO2 emissions.

Many of the main benefits to leasing a car if you’re self-employed will apply whether you choose a personal or business contract.

• Cheaper access to newer vehicles.
• A new car or van is likely to be more reliable.
• No depreciation costs (which can be as much as 40% at the end of the first year of ownership).
• Many deals will include Road Tax and the option to pay extra to cover servicing and maintenance.
• New cars will also still be covered with any manufacturer warranty.
• You can plan around fixed monthly payments

The key feature of car leasing is that you won’t own your vehicle until you potentially make a final payment. Which means you’ll be bound by the terms of the contract that you’ve signed, and won’t have a potentially saleable asset.

• You don’t own a saleable asset
• Most lease contracts will specify a maximum annual or total mileage, after which you may need to pay additional fees.
• You may not be able to end the agreement early, or have to pay significant charges if you want to hand the vehicle back sooner than planned.
• Modifications are typically not permitted.
• You’ll need to keep your vehicle well maintained. While fair wear and tear is allowed, you can be penalised for chips and cracks to any glass, dents and damage to bodywork and wheels, or any rips and tears to the upholstery or carpets.
• If you have taken out a PCP agreement and plan to buy your car at the end of the contract, the final balloon payment will usually be fairly large. And your circumstances may have changed a lot in the meantime.
• You’ll need to choose carefully to ensure you meet emissions regulations to reclaim all of your hire or lease costs.

Hiring or leasing a car is an allowable and tax deductible expense, but you must disallow 15% of your costs if the vehicle CO2 emissions are more than 50g/km. This was previously set at 110g/km for vehicles leased or hired before April 1st, 2021.

Petrol, insurance, repairs and other related vehicle expenses will need to be recorded and claimed as actual costs if you’re a limited company director. You can also choose this option if you’re likely to accrue significant expenses due to your profession or choice of vehicle. Sole traders can choose to use a flat rate mileage allowance as part of their simplified expenses, which provide a set amount per mile to cover all costs, and you can find out how to claim mileage allowance, here.

If you’re VAT registered then you can reclaim up to 100% of the VAT paid on monthly leases and any maintenance packages. 50% is claimable on cars which are used for mixed personal and work purposes, and for vans you can reclaim the exact percentage of business use.

If you’re choosing a personal contract or agreement, then you follow the same procedures as any other applicant. Business leases are available by any of the following companies or organisations:

• A sole trader/self-employed person
• A Limited Liability Partnership (LLP)
• A Limited Liability Company (LTD)
• A Public Limited Company (PLC)
• A charity, embassy, local or government authority

As part of the application, some or all of the following documents will be required, including proof of ID and address, recent bank statements and the most recent tax return. Even if you’re applying for a business lease, there will also be a personal credit check (including all partners in a partnership).

There are a wide range of car leasing and finance providers available, so make sure you take time to research and understand the options available before committing to a contract. And if you’re not sure about buying or leasing, or want advice specific to your individual situation, speak to a specialist accountant or tax advisor. IPSE members can find discounted offers from expert partners in our Marketplace.

Visit government website Gov.uk to read Travel – mileage and fuel rates and allowances. There is also an online tool that enables you to Check if simplified expenses could save your business money.