Impact of tax changes on company car fleet costs

2009-06-01

As the residual value of cars has fallen, contract hire schemes seemed like the best bet, but recent tax changes may have a bigger impact on fleet costs within an organisation, says Victoria Furness

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A car's residual value is the amount it is worth at the end of a leasing arrangement. These values fell sharply last year.
Company cars will be unaffected by falling residual values if bought through a contract hire scheme.
Staff that use a personal contract purchase leasing arrangement to finance a car should be protected from falling residual values if they have agreed a guaranteed future value at the start of contract. But the cost of their next lease may rise, so their allowance may not cover the same standard of car.
Cars bought or leased by employers are now taxed according to CO2 emissions

It wasn't just global stock markets that plummeted in value last year. The macroeconomic climate had a knock-on effect on the residual value of cars as the tightening of credit reduced demand in both the consumer and corporate markets.

Residual value is the amount a car is worth at the end of a leasing arrangement. According to auction house BCA, average used car values fell 3.7% to £4,765 last August compared with the previous month. Fleet and lease values were also down, falling 5.3% between June and July 2008, and by a more modest 1.2% the following month.

Although the market has begun to show signs of improvement, how the fall in car and lease values affects employers and staff depends on the type of arrangement an organisation has in place. If an employer owns a fleet of vehicles outright and provides them to staff as company cars, there is no risk to the employee from the car's falling residual value. But if an employer wants to sell the cars, it will have to bear a loss from the asset's depreciation in value. An employee faces the same risk if he or she uses a cash allowance to buy a car outright.

In a typical company car arrangement, the employer will be unaffected by falling residual values if it has leased the cars under a contract hire scheme. In this case, the risk lies with the leasing company as the cars are handed back at the end of the contract. This is also true of employee car ownership schemes.

However, company cars have fallen in popularity in recent years, with employees favouring a cash allowance that gives them more freedom to choose what car they want to buy, lease or hire. The flipside is that, depending on how the cash allowance is used, obtaining a car in this way could expose the employee to falling residual values.

As with a company contract hire arrangement, if an employee uses the cash allowance to lease a car through a personal contract hire arrangement, the leasing company bears the burden of any decline in residual value.

But if the employee has opted for a personal contract purchase (PCP) arrangement, there is a risk that he or she will be affected. PCP schemes give staff the opportunity to acquire the car at the end of the contract. In the past, employees might have realised a profit through buying and selling the vehicle, which was typically put towards a deposit for their next lease. But with falling residual values, Ross Jackson, chief executive of independent consultancy Fleet Operations, warns: "The likelihood of a profit at the end of the lease is almost non-existent."

If an employee agreed a guaranteed residual value at the start of a contract, they will not be penalised by the fall in their car's value, says Jackson. "But people will need to be prepared to receive rectification charges for any car that is either in excess of its contract mileage, or not in the condition the leasing company expects. Some companies are being ruthless in this area."

Falling residual values could also push up the cost of future leases, so an employee's cash allowance might not cover the same model of car as before. "We have seen lease costs increase by over 26% since this time last year," says Jackson.

As a result, some in the industry report a little movement back towards company cars. But for those tied into leasing agreements, there is some flexibility, says Chris Chandler, senior consultant at Lex. "With selected clients, we are extending lease periods so that instead of disposing of that vehicle in a downturn, they can keep hold of it for another year at a reduced rental rate, and hopefully return the vehicle to the market in better times," he says.

Meanwhile, tax changes are expected to make it more expensive for employers to lease or buy some cars. From 1 April this year, cars bought or leased are taxed according to CO2 emissions. Further changes, announced in this year's Budget, will come into effect in 2011. Graham Farquhar, a partner in Ernst and Young's employment tax division, says some employers might include more economical vehicles in their fleet as a result.

In the longer term, as residual values stabilise and even increase, which has already started to happen for some car types, it is this tax issue that is likely to have the biggest impact on employers and the makeup of their fleets