Any fleet funding specialists over 45 will remember two things with crystal clarity, where they where when they heard Kennedy had been assassinated and the relevance of August 1995. For those of you who are under 45 let me explain these milestones in history.

Before August 1995 companies were unable to recover the VAT on cars used solely for business purposes. Since this date leasing and contract hire companies, who only use the cars they lease for their business purposes, can recover the VAT and reduce their monthly rentals. 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.

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 basis 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). The company therefore eventually receives full tax relief for the difference between the purchase and sale price of each car.

For the cars that the company leases, however, the tax relief available 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 when new 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 but 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:

½ (Retail price)- £12,000)

Retail price

Examples of this are shown below:

Retail Price of Car (£) Deductible Rentals (%) Disallowed rentals (%) 12,000 100.0 0.0 20,000 80.0 20.0 24,000 75.0 25.0 50,000 62.0 38.0

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.

Of course we can use computers and maths to find the optimal financial position but non-financial considerations can have significant influence. For example:

• Some UK business, especially subsidiaries of American companies, lease all their cars regardless of cost because they do not want them showing on the balance sheet.
• Does carrying the risk of residual value shortfall outweigh the tax advantage?
• Is it worthwhile outsourcing all of the vehicle administration by using a fully managed product?

Is a good funding policy a result of art or science? I would suggest that it is only achieved by a good grasp of the numbers and a full understanding of the non financial needs of the company.

Finally Kennedy was an American President.

David Rawlings
Senior Manager
Deloitte & Touche