Vehicle Finance for SME's

Choosing the right vehicles for your business isn’t a simple decision.  You need vehicles that are fit-for-purpose, affordable, durable, and low maintenance.  Branded or not, your vehicles and their condition can speak volumes about your organization.

This article will help you understand the options available in the vehicle finance space for small businesses.

Let's dive in!

Small businesses seldom have the cash resources to purchase vehicles outright.  And if you do, it might not be the best use of your cash.  There are a few different kinds of Vehicle Finance for Business, for which you may be more or less eligible.  They can also affect the amount and timing of what you ultimately pay, and how your balance sheet looks.

While we can’t help you decide what vehicles to get, we can shed light on some of the aspects of Business Vehicle Finance that might influence your decision.

Claiming Input VAT on Business Vehicles

First off, in making your choice of vehicle/s and considering affordability, make sure you understand the circumstances under which you can, and cannot, claim input VAT.  

Unless you are a motor dealer or rental company, you are not permitted to claim input VAT on “motor vehicles” designed primarily for carrying passengers, and that includes multi-purpose vehicles and double-cab bakkies.  It doesn’t matter if the vehicle is used exclusively for the delivery of goods.

Single cab bakkies, buses designed to carry more than 16 persons, and motorcycles do not fall under the SARS definition of “motor vehicles”.  They will qualify for input VAT if they are genuinely used for business purposes (which doesn’t include travelling between home and work).  However, it is always best to check with your accountant before making an assumption either way.  

Note that this is irrelevant for non-VAT vendors, or micro businesses paying turnover tax.

Instalment Sale Agreements (ISAs)

Instalment sale agreements (ISAs) are the most conventional vehicle finance in South Africa.  It’s how most private individuals buy cars.  Don’t get too caught up on the technical name – it is simply a loan for the full purchase price of the vehicle.  Business vehicle finance ISAs can be made directly with the motor dealer, vehicle finance companies, or through your bank.  It’s not a given which one will offer the better deal so speak to more than one.  

Let’s look at the elements of an ISA;

Deposits

Paying a deposit will reduce your monthly instalment, the bigger the deposit, the lower your instalments.  And, the less interest you will pay over all.  Instalment sales do not "reward" you for lump-sum additional payments in the course of the contract, the way mortgage loans do.  In fact, most will penalize you for early settlement.  So, if you want to put a cash component towards your vehicle purchase, do so at the start.

Balloon payments

These are large lump sums at the end of the Business Vehicle Finance contract that you will have to pay before ownership of the vehicle transfers to you.  They are a mechanism to reduce the monthly instalments but will increase your total payment because interest accrues on the deferred payment.  At the end of the contract, the balloon payment could well be in excess of the car's value.  And, if you don’t have the cash to pay it, you may be left with no option but to roll it up into another loan.

Interest rates

These will be fixed or linked to prime, and you'll often be given a choice.  A fixed rate means you'll never be hit unexpectedly by rising instalments you can't afford to pay.  But it can be frustrating if prime goes down and you’re left paying the higher rate on your Business Vehicle Finance.

Term

This is the period of the loan in which you'll have to repay it.  Vehicle instalment sales are typically 4-5yrs, but you can make it anything from 12 months.  

With an ISA, ownership only transfers to you at the end of the loan period.  But you are responsible for all maintenance and insurance.  However, there is no restriction on the vehicle’s use, as there can be with a lease.

The accounting treatment for an ISA creates an asset and a liability of the loan on your balance sheet.  On your income statement, the interest is expensed over the period of the loan, and depreciation over the useful life of the asset (note these may not be the same).

The tax treatment of an ISA allows input VAT (if applicable) to be claimed on the earlier of delivery or any payment, in other words, upfront.  Interest is tax-deductible over the period of the loan, and depreciation is allowed as per SARS’s wear and tear allowances.

Operating Leases

With an operating lease, ownership of the vehicle never transfers to you.  You are just paying a monthly instalment for the use of the vehicle, after which you hand it back.  

With this kind of business vehicle leasing, there are no deposits or balloon payments, and no interest.  The terms of operating leases tend to be shorter than instalment sales, and the instalments lower.  Maintenance and insurance can usually be included in the instalments.  However, there are typically restrictions on the usage of the vehicle that incur penalties if infringed e.g. a specified maximum mileage.

The accounting for an operating lease doesn't affect your balance sheet at all.  Your monthly instalments are expensed as they occur.

The tax treatment of an operating lease is, likewise, to treat the instalments as a tax-deductible expense as they occur.  Input VAT (if applicable) can be claimed at the time of each instalment and is based on the instalment figure, not the purchase price of the vehicle.

Finance Leases

These are sometimes called Capital Leases.

Finance leases are leases where ownership of the vehicle does transfer to you at the end of the contract, for a nominal fee.  These types of leases were set up to facilitate off-balance-sheet vehicle and asset finance by making instalment sales look like leases.  As such, they misrepresent the real state of affairs, and the accounting treatment of them tries to correct this.  It can get quite complicated and lands up being reversed for tax purposes, which has an impact for your balance sheet and cash flow.

The accounting treatment of a finance lease says that if the life of the lease exceeds 75% of the asset life or ownership is transferred to the lessee, or there is a "bargain price" option at the lease end, or the current lease payments exceed 90% of the fair market value of the vehicle; then you have a finance lease.  And then the lease is treated like an ISA on the balance sheet and income statement.  The values that get used take into consideration the current market value of the vehicle and implicit finance costs.  

The tax treatment of finance leases is to add back the interest and depreciation charges and claim the instalments as a tax-deductible expense (less any input VAT that may have been claimed at the time of each instalment).

Because lease periods and useful lives (for depreciation purposes) don't necessarily tie-up, when you take over ownership at the end of the contract, recoupment entries may need to be made.  For greater detail and examples of the accounting and taxation of finance leases refer to SAICA.  But better yet, ask your accountant to provide you with the implications for your business.

Requirements for Instalment Sales Agreements vs Leases

With Vehicle Finance for Business, the vehicle acts as the security.  This makes business vehicle loans slightly more accessible than other, unsecured business funding.  However, most financiers will not consider financing a business that has been trading for less than two years.  Additionally, you will have to provide financial statements demonstrating the ability to service the debt.  Your personal credit score, as well as that of your business, will need to reflect good standing.

For lease agreements, a minimum trading history of six months is usually sufficient.  But you must be able to demonstrate you can generate adequate regular cash flow to pay your instalments.

Documentation Requirements

Documents you will need to have available for commercial vehicle finance include;

•       Company registration papers (showing registered address)

•       VAT registration certificate

•       Banking details

•       Owners’ details (directors, members)

•       Business contact details

•       Details of what you want to finance  

To Finance or Lease – which is Better?

A simple (-ish) approach to answering this question is to perform a present value calculation on the options.  However, there are other benefits to consider.  And, unless you have a specific desire to own your vehicles, the benefits stack up mainly on the side of business vehicle leasing as follows;

•       Operating costs are fixed.

•       Small businesses have limited access to credit, and where they do, they might need it for other purposes (even big businesses often decide on leasing their fleets because it doesn’t tie up capital or use up credit lines).

•       Lease agreements are simple, with no extra loan covenants or guarantees.

•       Vehicles are upgraded more regularly, and you don't have the hassle of getting rid of old vehicles.

•       When leases include extras like maintenance and insurance, they often come cheaper than they can be procured separately.

•       Leases often come with fleet management services and advice from experts, leaving you free to get on with your business operations.

•       In the case of operating leases, debt is kept off your balance sheet – this is important for businesses that have to meet specific capital requirements.

While there’s no one right answer, we’ve hopefully given you enough information to ask the right questions to make an informed decision.  Keep in mind that tax and accounting rules can change, so it’s always a good idea to have your accountant involved in the decision.