The ultimate guide to paying taxes on leased cars

7th Apr 2021

The ultimate guide to paying taxes on leased cars

There are two things that are certain in life – death and taxes. Or are they? When it comes to leasing a car, you’ll be pleased to hear that there are allowances for certain taxes.

In particular, we’re referring to Vehicle Excise Duty, (road/car tax), Value Added Tax and Benefit in Kind tax. So, let’s start with the simplest one – road tax.

How do they calculate road tax?

Car tax is categorised by bands based on emissions. (Please note this excludes cars registered before 2001, but as we’re talking about leasing, it’s very unlikely you’ll lease a car this age!)

The amount you pay will be based on specific attributes of the vehicle, including:

• Engine size

• Fuel type

• CO2 emissions.

For cars registered between March 2001 and April 2017, the first year’s road tax is cheaper – which is widely dubbed as a ‘showroom tax’. This is completely free for vehicles with emissions of less than 130g/km for the first year. If the car has emissions of less than 100, road tax is always free.

Vehicle Excise Duty bands are categorised from A to M, starting with the lowest CO2 emissions. They then rise incrementally (charged for a year or six months) for every 10g of CO2 per km that they emit.

Charges for ‘alternative fuel’ cars such as hybrids, plug-in hybrids or those that use LPG, CNG or biofuel are charged at £10 less than diesel or petrol vehicles.

What about vehicles registered after April 2017?

Unfortunately, this government incentive to buy low emissions cars backfired for the Treasury. With the advent of newer, cleaner cars, the government soon realised that many cars were paying very little road tax thanks to their lack of emissions.

As such, new laws were proposed, which affected some motorists positively, and some negatively.

Road tax on these vehicles continues to be calculated based on emissions. However, rather than the 100g/km limit, only cars with 0g/km will be exempt from paying road tax altogether – that is, electric only cars.

The showroom tax for the first year continues, but cars with more than 0g/km will have to pay a flat rate of £140 per year after the first year. This means that anybody whose vehicle would have been classed beyond band G – or 151-165g/km – will actually pay less from now on.

However, there’s one more caveat. If the car has a list price (i.e. the manufacturer recommended purchase price) of more than £40,000, then the driver will need to pay an additional £310.

What are the car tax changes in April 2020?

Just when you thought it couldn’t get any more complicated – the rules changed once again in April 2020. While the way that tax is calculated hasn’t changed, the testing for emissions has.

All cars registered after April 2020 will now undergo the Worldwide-Harmonised Light Vehicles Test Cycle (WLTC). This is a change from the former New European Driving Cycle (NEDC) test, which gave less accurate results, and as a result, often labelled cars as more environmentally friendly than they actually were.

This may mean that some cars registered after this date will be listed as having higher emissions than before. The only thing this affects is the first-year tax rate, as this is the reduced ‘showroom’ rate. Cars may be pushed up into higher brackets, but for any subsequent years, the fee will be a standard flat rate of £150.

This only really becomes an issue for cars with emissions of 131g/km and up, as the showroom tax rate begins to jump significantly. However, there’s also a higher tax on diesel vehicles.

Effects on diesel cars

Cars registered from April 2020 have been significantly penalised by the government in an attempt to encourage more environmentally friendly vehicles. For example, the first-year rate for a petrol car with emissions of 51-75g/km is only £25, whereas for diesels it is £110.

It jumps up even more significantly when emissions go beyond 131g/km – from £215 to £540. The highest polluting diesel cars are charged at £2,175 per year. Keep in mind, though, that these inflated rates only apply for the first year. It’s plain sailing after that!

How this affects leased cars

The good news is that personal car lease deals come with road tax included as part of the package. For as long as you’ve agreed to rent the car, the lease company will cover the road tax.

But this may have an indirect effect on you – you might notice that the overall leasing package is costlier for certain vehicles registered after April 2020. If you’re concerned about looking after the pennies, and would like to have less of an impact on the environment, try to stick to petrol or alternative fuel cars as opposed to diesel.

Taxes on personal leases

One of the many benefits of personal leasing is avoiding heavy road tax fees, particularly the ‘showroom’ tax if you do choose a vehicle with higher emissions. It may be disconcerting not to tax the car yourself, but you can check to be sure – simply use this DVLA checker and enter the vehicle’s registration number.

What you won’t get with a personal lease is savings on VAT. This is for businesses only, while there are also other benefits for business lease customers depending on the vehicle they choose, and any maintenance packages.

Implications for personal contract purchase

One thing to be aware of is personal contract purchases. These are slightly different from leasing contracts as they result in car ownership. With a lease, you simply go through the credit checks, pick a car, decide the length of your contract and give the car back when it’s done.

With personal contract purchase, you lease – or rent, in effect – the car for your agreed lease contract with the provider. Once this contract term is up, you don’t return the car or swap it for a new one. Instead, you’ll pay what’s known as a ‘balloon payment’.

This is a large payment that covers the final value of the car, with consideration for depreciation over the course of the leasing contract. What is paramount to understand is that once the car is yours, you’ll have some new responsibilities.

Beyond the standard leasing contract, your agreement may optionally include:

• Maintenance

• Insurance

• Fuel.

Bear in mind that, once your leasing contract is up, it is your responsibility to pay your annual road tax and insurance. Use the DVLA checker to see when your road tax is up for renewal, and speak to your local car dealer about any maintenance packages if you have them.

You should also shop around for insurance packages – expect these to be a little more expensive than they were as part of your package, as they will essentially be a new deal with new premiums.

Taxes on business leases

Business leasing is a great incentive for staff teams, and can save considerable amounts on taxes. The bad news is that business lease deals do not cover road tax. The good news is that you can make savings elsewhere, such as on VAT.

When you lease a car through your business, you can reclaim 50% of the VAT on the monthly repayments. Even better, if the car is exclusively for business use (for example taxis, as opposed to cars used for commuting), you can reclaim up to 100% of the VAT back.

What’s more, if you have a maintenance agreement with your business lease, you can claim back up to 100% of the VAT on this too.

Benefit in Kind tax

One unwelcome facet of business leasing is Benefit in Kind tax. This is an income tax payable by the driver of the car, and it applies to any company benefits such as cars, healthcare or childcare. Benefit in Kind is calculated based on your annual salary, the value of the car, and the car’s emissions. You can estimate your monthly payments with this calculator.

Again, there’s an incentive here to choose the environmentally friendly option. Based on the new emissions testing, electric cars registered after April 2020 will not be subject to any Benefit in Kind tax. This will only rise marginally, to 1% in 2021/22 and 2% for 2022/23.

If the car was registered before April 2020, the Benefit in Kind tax will increase to 2% in 2021/22 and for the next two years thereafter.

Either way, there is still an incentive to choose an electric or alternative fuelled car. Plug-in hybrids, for example, with an electric range of 25 miles, will have a tax rate of just 12 to 14%.

Read more in our Benefit in Kind tax guide here >

Ready to roll?

Whether you’re going all in with insurance, maintenance and fuel, or just opting for a standard package, leasing offers significant tax breaks. Our leasing agents will help you to find the best deal for you based on business and/or personal needs. Plus, we’ve got a comprehensive range of environmentally friendly vehicles to keep those costs down.

Contact us for more information here.