In last week's bulletin
we looked at the considerations when you lease a business vehicle.
Today we look at what would happen if John decided to buy instead of lease a vehicle. As with leasing, deciding to buy business vehicles isn't a one size fits all rule. There's a lot to think about before you make the decision, especially if you need to purchase more than one vehicle for your business. Let's have a closer look at buying…
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What would it cost John to buy these vehicles?
If John had decided to buy two business vehicles for his sales staff instead of leasing them, his financial situation would be very different. Let's assume John had R100 000 capital to put down as a deposit for both vehicles. So he puts R50 000 down on each. Each car is priced at R150 000, so John has R100 000 to pay on each vehicle, with a total of R200 000 repayable.
John's happy about the tax implications, because he's able to write off the interest on the new-car financing loan from the dealer.
What are the financial implications of buying a business vehicle?
If you buy the vehicle
from the dealer, or private seller, you'll usually get finance, unless you have upfront capital to pay the bill. With financing, you drive the vehicle, but the bank owns the it until you've finished paying it off. You make monthly repayments to the bank for a specified amount over a specified period.
After you've paid your installment, you take full ownership of the vehicle. The interest rate applicable on this sale agreement can either be fixed or a variable. This depends on your agreement with the bank.
John decides to pay off his business vehicles in 60 monthly (5 year) repayments. Let's look at the financial calculations he did when he made this purchase.
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So how does John account for wear and tear?
Because John uses the vehicles for business operations, it'll qualify as a tax.
He can reduce wear and tear from his taxable income at a certain rate over the vehicle's lifetime. For business vehicles, the rate's fixed at 20% for the first five years if the business vehicles used for production or operating activities. If it were a farming business, vehicles like bakkies and motorbikes, have a variable rate of application, namely 50% of the net purchase price (so Vat is excluded) in the first year, 30% in the second year and 20% in the third year.
So John's two vehicle's entire purchase price can be deducted as an expense from the business operation.
If John decided to buy by hire-purchase or other financing scheme, he can deduct the annual interest accrued from his taxable income. This is only valid for the interest portion and not for the capital portion. He basically deducts the capital as part of the wear and tear.
He can deduct the interest annually until he's settled the outstanding amount. If John's financing agreement stretches over five years, he can deduct the interest portion from taxable income for each of the five years.
John bought the vehicles at a fixed rate of prime plus 1% because an old college friend helped him negotiate a great interest rate for his car financing.
What would John's financial calculations look like?
John's financial calculations were in-line with IFRS, and looked like this:
The full cost of the two vehicles is R300 000 – the deposit amount of R 100 000 = R200 000 to be paid off on the vehicles over a period of 5 years.
The monthly repayment on the vehicles would be the value of R 200 000/60 (5 year period) = R3 333.33 plus interest at prime rate (which is currently 8.5%) plus one %.
The tax implications for the first year will be as follows:
Interest deductible for tax purposes:
One year which is 12 (monthly repayment amount R3 333.33 x 9.5% prime plus one= R316.67 interest deductible for tax.
The wear and tear allowance will be the full cost of the vehicles which are R300 000 x 20% which is the fixed rate for all five years of the net purchase = R 60 000.
If John bought the vehicles at a variable rate, his monthly repayments would fluctuate. Either way, the interest's still deductible.
Should John have bought our leased the vehicles?
If you looked at part one of this article, you'll see John preferred the operating lease to buying because he likes to portray the quality of his brand through the presentation of his sales team and thus get new vehicles for his sales guy's every two years.
But buying comes with its own positives. In part one where he leased the vehicle, his lease payment for the first year was R10 000 per month and in the second year R8500 per month. After two years he'd lease a new vehicle. Whereas if he buys it, he'll pay R3 333.33 plus interest per month, and own the car at the end of 5 years.
At the end of the day, the choice is yours to make regarding to buy or lease. Look at the various options available and work out the one that fits your business perfectly. In John's specific business, he'll definitely benefit entering into a lease agreement because of the nature of his business.
An amount of R 111 000 will be reflected accordingly in the income statement for the first year whereas an amount of R 60 000 for the first year plus interest of R 316.67 would have been used should the vehicles been bought at a price of R 150 000 each at prime rate plus one.
But one thing is certain, don't make any financial agreements that limit your cash flow and opportunity to do business. If you need a new vehicle every two or three years it would be better to enter into a lease agreement rather than buying considering the tax implications. If you need a vehicle for a few years and want to give your balance sheet a bit of a capital injection it would be better to buy.
John's next step is to account for the company car as an employee cost. Want to know how to do this? Turn to chapter E01: Employee benefits
in your Practical Accountancy Loose Leaf,
for detailed information on how to do this. Don't have a copy? Click here for yours
Until next time.
Yours in accounting,
Jan van Zyl
P.S. Got a burning company car question? Find the answer at Accounting and Tax Club