This article looks at the dual tax rules that will exist for the next five years on cars held by companies and individuals following the recent alignment of tax rules with car Co2 emissions. It considers the impact on cars held on the balance sheets (i.e. purchased or on HP) and those lease financed, where they remain off the balance sheet, i.e. an operating lease.
The relevant date of commencement of the new rules is 1 April 2009 for companies and 6 April 2009 for individuals (i.e. the start of the 2009/10 tax year). The term “grandfathering” is tax speak for allowing the old ‘list price’ rules to continue to apply to cars held at and beyond the date of transition.
Welcome to another green stealth tax!
Cars on the company balance sheet – the old rules
Tax relief for cars on the balance sheet is via capital allowance relief and where the list price of a car was less than £12,000, the car would be included in the main capital allowance pool and attract a capital allowance rate of 25% or 20% from 1 April 2008.
Where the list price exceeded £12,000 (i.e. it was an ‘expensive car’) the car would not be included in the main pool but listed separately in a ‘special pool’ and attract tax relief that was then restricted to a maximum claim of £3,000 per car.
Any early restriction on tax relief for expensive cars was later reversed as a significant tax advantage arose on the date of sale because it was possible to make a claim for the balance of any unrelieved capital allowances.
This can be illustrated by examining a car purchased for £40k, owned for three years and sold for £18k as in the final year there is a significant capital allowance claim of £16k (i.e. a ‘balancing allowance), to ensure that total capital allowance claims equal the fall in value of the car.
| Event | Transactions | Capital allowances |
|---|---|---|
| Purchase car | £40,000 | £3,000 |
| Retain car | £3,000 | |
| Sale of car | (18,000) | £16,000 |
| Loss on sale | £22,000 | |
| Tax relief in 3 years | £22,000 |
From 1 April 2009 the grandfathering rules will ensure that cars on the balance sheet at 1 April 2009 will continue to be treated under the above rules.
Cars on the company balance sheet – the new rules
Under the new rules cars with Co2 emission ratings of less than 160g/km will be included in the main capital allowance tax pool and benefit from a 20% rate while cars with a Co2 emission value over 160g/km will be included in a pool attracting a lower 10% rate
More fundamentally, however, the new rules prevent a claim for any balancing allowance at the date of sale of a car and this will result in very long delays in obtaining tax relief as no longer will the financial loss be matched by immediate tax relief.
The table below illustrates how long tax relief will take under the new rules in the special 10% pool and main 20% pool.
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|---|---|---|---|---|---|---|---|---|---|---|
| Rate of 10% | 10% | 19% | 27% | 34% | 41% | 47% | 52% | 57% | 61% | 65% |
| Rate of 20% | 20% | 36% | 49% | 59% | 67% | 74% | 79% | 83% | 87% | 89% |
Thus tax relief of 27% of the car cost will be obtained after 3 years of ownership in the main 10% pool.
The true impact of future cashflow lag under the new rules can be illustrated by taking the above example and letting the car have a Co2 emission value of over 160g/km and hence fall into the 10% rate.
| Event | Transactions | Capital allowances 10% |
|---|---|---|
| Purchase car | £40,000 | £4,000 |
| Retain car | £3,600 | |
| Sale of car | (18,000) | £1,440 |
| Loss on sale | £22,000 | |
| Tax relief in 3 years | £9,040 | |
| Tax relief in next 7 years | £6,761 | |
| Tax relief in 10 years | £15,801 |
The above illustrates that total tax relief across 3 and 10 years is £9,040 and £15,801 and that after 10 years the business is still waiting on relief of £6,199 (ie. 15,801 + £6,199 = £22,000).
By the end of year three, tax relief has been denied on £12,960 of vehicle loss (i.e. £22,000 less £9,040) resulting in the company making forward corporation tax payments of £2,722 (using the small company rate of 21%), i.e. £12,960 x 21%.
Also, from my table above, we know that it will take 10 years just to get back 65% of this forward tax payment for a car in a 10% pool.
Therefore the new rules are far from business friendly and any financial loss will be compounded by multiple vehicle ownership and every future car replacement.
Cars on the individual’s balance sheet – old and new rules
With respect to the rules changes there is good news for sole traders and partners as cars with both business and personal use will continue to receive a final balancing allowance at the point of sale of the car.
A sole trader or partner may own a car without private use (i.e. so called ‘pool cars’) and unfortunately this car will be caught by the new rules and the loss of any balancing allowance.
Cars not on the balance sheet – companies and individuals
The old rules
Tax relief for cars on an operating lease is provided by allowing a deduction for the lease cost in the profit and loss account.
Under the old rules the greater the excess of a list price over £12,000, the greater the percentage of the lease costs disallowed. For example cars with a list price of £12,000 and £17,000 had 0% and 15% of the costs disallowed, respectively. While cars costing £50,000 had nearly 40% disallowed.
Grandfathering rules ensure that the old rules continue to apply to cars for the remainder of their lease term and this applies to both companies and individuals equally.
The new rules
From 6 April 2009 the new tax rules have brought about a considerable simplification as cars with a Co2 emission of less than 160g/km will have no restriction applied to the lease charges.
Cars with a Co2 of 160g/km or more will have tax relief on their lease charges restricted by a flat rate of 10%.
This simplification will result in some winners and losses but leased cars costing over £14,000 will benefit under the new rules.
Summary
In summary, it is now very important to consider cash flow and tax relief timing before buying a new car.
Please contact me if you wish to discuss how much car ownership is costing you or how to make tax savings.
copyright ©2009
This article is for discussion purposes only and does not represent advice on which you should act without consulting a professional as tax legislation is complex and changes frequently.