For most companies the search for ways to reduce overheads is never-ending. The company car fleet is one area that will be closely examined by many departments, since many cars are not only a necessary tool but also represent a visible form of remuneration. There are so many ways to finance the company car, that finding the cheapest option can be a difficult and time-consuming process. Direct cost, for some companies, may be the predominant issue, but for others there may be more important factors to consider, for example;

• is the fleet large enough to benefit from significant supplier discounts?
• could the company make better use of the cash tied up in the fleet?
• who should take the risk on residual values?
• does the cost of providing the fleet need to be "off-balance sheet"?
• should the management of the fleet be outsourced?
• should we offer our company car drivers a cash alternative?
• should we have company cars at all?

This list is by no means exhaustive. Although the answer can sometimes be straightforward, there are usually many other factors that have to be taken into account; this can complicate matters. If this is the case, the task needs to be broken down into its constituent parts so that decisions can be reached in respect of each particular alternative. For example, if the most important issue is that cars are off-balance sheet, contract hire may provide the solution. However, if the fleet consists of high value vehicles, then a purchase agreement may be the cheapest option. If the right decision is to be reached, then the various requirements need to be carefully balanced.

The logical starting place is to consider whether to "lease or buy"? To do this, consideration of the potential tax effects (both direct tax and VAT) are essential as these play a vital role in reaching the correct decision. As the car is likely to be kept for several years a discounted cashflow calculation will also be required.

The decision to lease or buy became more relevant after the changes to the VAT legislation were introduced in August 1995. Since this date, companies using cars solely for business purposes can recover the VAT incurred because leasing and contract hire companies only use the cars they lease for their business purposes; it is irrelevant what the lessee does with the cars. Therefore the monthly rentals are reduced. However, two factors offset this saving:

• lessors have to account for the VAT when they sell the cars;
• lessees can only recover half the VAT that had previously been recoverable on the rental.

Consequently this means that there is a reduction in the cost of leasing or contract hiring a car compared to pre August 1995 due entirely to the VAT saving. This leads to leasing (which includes contract hire) being significantly more attractive than purchasing (which includes outright purchase, contract purchase, and hire purchase) from a VAT point of view.

Corporation tax or business tax relief, on the purchase of a car is achieved by way of capital allowances. These are set at a rate of 25% per annum on a reducing balance with a maximum deduction of £3,000 for a car costing over £12,000. For tax reasons a car costing over £12,000 is called an " expensive" car (obviously this has not changed for some time).

This means the company will eventually receive full tax relief for the difference between the purchase and sale price of each car.

For the cars that the company leases, the tax relief available to the company will normally be received when the rental payments are charged to the accounts.

With leased cars a problem arises when the retail price of the car exceeds £12,000, as a permanent tax disallowance is applied to the monthly rental. The term 'retail price' is not precisely defined in the tax legislation. The Inland Revenue regard the term to be the price an ordinary member of the public might pay, which therefore includes VAT and excludes bulk or special discounts. In April 2000 the Inland Revenue published a bulletin stating that where the lessee knows the actual price paid by the lessor for the car when new, this can be used as the retail price when new, but must include VAT.

 The disallowance is based on the following formula:

So for example the proportion of rentals disallowed would be:
 

Retail price of car (£) Deductible rentals (%) Disallowed rentals (%) 8,000 100 0.0 12,000 100 0.0 14,000 92.9 7.1 18,000 83.3 16.7 22,000 77.3 22.7

While the VAT rules usually favour leasing, the direct tax rules make purchasing progressively more attractive for those cars with a retail price in excess of £12,000. At first sight, it would seem relatively straightforward to find the point at which the company should change its method of finance from leasing to purchasing. However, the break-even point is sensitive to several other factors, such as:

• the car’s residual value;
• the month of acquisition, in relation to the company's financial year-end;
• the company's tax and VAT recovery rate;
• the company's internal rate of return.

To assist the fleet decision-maker to decide on the correct funding method, Deloitte & Touche have developed "Fleet Choice". Using data from what we consider to be a typical company and then analysing a typical company car, we find that the break-even point occurs at around £20,000. However, if the company pays tax at the small companies rate this figure increases to nearly £26,000.

It is possible for a company that wants to purchase its cars to benefit from the VAT rules that apply to leasing. This is achieved by establishing an in-house leasing company. A new subsidiary company is set up to buy the cars and then onward lease them to the operating companies, effectively mirroring an external leasing company. In order for the in-house leasing company to work, the rentals charged must be on a proper commercial basis or the scheme is likely to fail. The break-even points referred to above will still apply, so this may not be beneficial for all cars. Additionally the company will need to have a sufficiently large fleet to make this worthwhile.

Recent years have seen a marked increase in the number of employees being offered a cash alternative to their company car. The company and the driver may take into account many non-financial motives when reaching their decision. However, from a purely financial view, the cash alternative can be a viable option in some instances.

The most effective schemes are ones that take full advantage of the Approved Mileage Rates which allows the employee to receive Inland Revenue approved amounts per mile in a tax and National Insurance free manner. These are especially effective where the employer provides a degree of support to the employee in areas such as finance and bulk purchasing power.

To make the cash alternative work, the employer is faced with major financial calculations. These in turn will have to be explained to the employee. Computer modelling makes this process effective and is essential if both the employee and the company are to fully evaluate the various "what if" scenarios.

In conclusion, finding the correct method of funding is not easy, especially as the optimal position may be achieved by some cars being purchased, some leased and some cars being replaced with a cash alternative. However, for the decision-maker who is prepared to invest time, and perhaps some money, it would be surprising if substantial savings could not be found.