What Is Contract Hire?

Contract Hire is form of leasing to get the use of a vehicle without taking ownership of it.

The leasing period (or 'term') is usually a number of months or years during which the vehicle is still owned by the leasing company (the 'lessor') but is rented to the user (the 'lessee').

Effectively the lessee is borrowing the vehicle from the lessor for a fixed period in return for a lease payment (or 'rental').

What's In Contract Hire Rentals?

During the lease period the lessee pays a rental to the leasing company which covers the costs incurred by the lessor to operate the vehicle, plus a profit for the lessor.

In other words, the lessee pays for:

  • The depreciation in the value of the car over the life of the lease
  • Vehicle Excise Duty
  • Interest Charges on the money borrowed by the lessor to buy the vehicle on behalf of the lessee
  • The lessor's profit margin (which might be just the interest charges)
  • VAT
  • Maintenance (Optional)

At the end of the lease period the lessee normally returns the vehicle to the leasing company. The leasing company disposes of the vehicle and takes any profit or loss on the sale.

Contract hire is sometimes described as a 'partly amortised' or  'balloon' finance product. 

'Amortisation' is the process of writing off the cost of an item over a period of time.  With partly amortised or balloon leases such as contract hire only the expected depreciation in the value of the vehicle is repaid to the finance company over the finance period (the 'term').  In contract hire the expected residual value of the vehicle is left unpaid and at the end of the contract the lessee simply hands back the vehicle.

Because the lessee pays only for depreciation during the period of the lease (the 'term'), as each monthly instalment is paid the payment reduces the outstanding amount financed at a much slower rate than in 'fully amortised' leases.

Because less of the purchase price is repaid in each payment, assuming interest rates are the same in both fully amortised and balloon leases, the total interest charges in a contract hire arrangement are more than those in a fully amortised finance product such as finance leasing or hire purchase (because more money is left unpaid during the term), so the overall costs of finance for contract hire are higher than those of a fully amortised lease.

However, repaying a lower amount of the purchase price each month means that the actual monthly payments are lower in contract hire than for a fully amortised lease.

Advantages of Contract Hire

Because the leasing company recovers VAT on the price of the vehicle the rentals for passenger cars will be lower than comparable finance instalments for contract purchase.

Because the vehicle is leased, the normal responsibilities of ownerhip, such as sourcing the best deal and obtaining the best resale (or 'residual') value, are avoided, as is the risk of the residual value being less than expected.

In effect, the lessee simple operates the vehicle rather than owning it, so contract hire is sometimes referred to as an 'operating lease'

Under accounting conventions applying at the date of publication, contract hire does not need to be disclosed on the balance sheet of a business as a liability. This status can improve the appearance of the financial position of a business.

Disadvantages of Contract Hire

If the lease agreement is terminated earlier than expected then the lessee may be required to pay a penalty (usually a number of months rentals).

In addition, if the vehicle is returned with more mileage than that agreed for the term of the lease, or is not in a condition appropriate for it's age and the lease mileage, then 'end of contract' charges may be made by the leasing company.

Under new accounting conventions proposed for larger businesses contract hire will need to be disclosed on the balance sheet (eventually all businesses will be required to disclose contract hire agreements).

VAT incurred on the lease rentals cannot be recovered in full on passenger cars used for private purposes by employees - only 50% of the VAT incurred can be recovered.

Tax relief for the lessee on cars with a CO2 output over 110GP/Km is restricted (50GP/Km from April 2021), thereby increasing the total costs to the lessor of providing contract hire for cars with higher CO2 emissions.

This can result in lessors charging higher interest rates in contract hire agreements for cars with a CO2 output of more than 110GP/Km in order to recoup the lost tax relief.

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