How financing an asset affects Capital Allowances, AIA, tax relief and VAT – updated for 2026

Originally published 3 December 2021 – substantially updated September 2026

When businesses purchase assets they normally use finance, it makes sense to conserve your cash and spread the purchase cost over the life of the asset, but how will you choice impact on whether you can claim Capital Allowances, Annual Investment Allowance? First-Year Allowances? tax relief on finance costs? VAT?

You can claim capital allowances when you buy assets that you keep to use in your business, for example:

• equipment
• machinery
• business vehicles, for example cars, vans or lorries

These are known as plant and machinery.

You can deduct some or all of the value of the item from your profits before you pay tax.

So clearly buying assets without finance or with a business loan is fine as you will definitely own the asset.

HIRE PURCHASE

PCP

or:

LEASING

And from 2026 there are important new capital allowance rates and new FRS 102 lease accounting rules to consider.

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Quick Answer – Cash, HP, PCP or Lease?

Method	Who normally owns the asset?	Capital allowances for user?	Broad tax treatment
Cash purchase	Business	Normally yes	Capital allowances
Business loan + purchase	Business	Normally yes	Capital allowances + qualifying finance costs
Hire Purchase	Ownership will or may pass	Potentially yes	Special HP capital allowance rules
PCP / Contract Purchase	Depends on agreement	Depends on agreement	Contract must be reviewed
Ordinary lease	Lessor	Normally no	Appropriate rental deductions
Long funding lease	Lessor legally	Potentially lessee	Special tax rules
Contract hire	Hire company	Normally no	Appropriate rental deductions

The important point is:

The name printed on the finance agreement does not always determine the tax treatment.

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Hire Purchase

The normal assumption is that an asset bought under a Hire Purchase agreement will become the property of the hirer once the relevant payments and any purchase option have been completed.

The original version of this article referred to Section 67 Capital Allowances Act 2001, which remains important.

Special capital allowance rules apply where an asset is provided under an agreement under which ownership will or may pass to the person using it.

This means a business does not necessarily have to wait until the final HP payment before obtaining capital allowances.

HMRC’s current guidance states that where an asset is bought under Hire Purchase and has been brought into use, capital allowance claims can take account of the payments that will be made under the contract, excluding the interest element.

If the asset is ultimately not acquired, the capital allowance rules can require an appropriate disposal adjustment.

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Can You Claim AIA on Hire Purchase?

Potentially, yes.

Using Hire Purchase does not automatically stop a qualifying asset from benefiting from the:

ANNUAL INVESTMENT ALLOWANCE

The AIA remains available on qualifying plant and machinery, subject to the relevant conditions and limits. The current annual limit remains £1 million.

Consider this example.

Machine cost

£100,000

Deposit

£10,000

HP finance

£90,000

It would be wrong to assume the capital allowance claim must simply be limited to the £10,000 cash deposit.

Where the HP and AIA rules are satisfied, substantially more of the qualifying capital cost may potentially receive relief.

This can produce an important cash-flow advantage:

TAX RELIEF CAN ARRIVE BEFORE ALL THE HP PAYMENTS HAVE BEEN MADE

The finance interest and charges are not part of the capital allowance cost and need to be considered separately.

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What’s Changed Since This Article Was First Published?

When this article was originally published in 2021, the capital allowance landscape looked rather different.

There are now three particularly important 2026 changes.

1. New 40% First-Year Allowance

From:

1 JANUARY 2026

a permanent 40% First-Year Allowance is available on qualifying new and unused main-rate plant and machinery.

2. Main Writing-Down Allowance Reduced

The main-pool writing-down allowance reduced from:

18% → 14%

from:

• 1 April 2026 for Corporation Tax; and
• 6 April 2026 for Income Tax.

3. New FRS 102 Lease Accounting

For accounting periods beginning on or after:

1 JANUARY 2026

revised FRS 102 Section 20 significantly changes how most leases are accounted for by lessees.

These changes make it particularly worthwhile reviewing the finance method before signing an agreement.

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New for 2026 – 40% First-Year Allowance

The new permanent 40% First-Year Allowance applies to qualifying:

• new;
• unused;
• main-rate plant and machinery

acquired on or after 1 January 2026.

The allowance lets the business deduct:

40% OF THE QUALIFYING COST

in the first year.

The remaining balance can subsequently qualify for writing-down allowances.

The new allowance is particularly interesting because it has fewer restrictions than some existing FYAs and was specifically designed in part to improve relief for areas such as leasing businesses and unincorporated businesses.

But there are exclusions.

In particular:

CARS DO NOT QUALIFY

and:

SECOND-HAND ASSETS DO NOT QUALIFY

for this new 40% FYA.

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AIA or 40% First-Year Allowance?

If an asset qualifies for more than one form of capital allowance, the business may have a choice over which allowance to claim. HMRC confirms that where an item qualifies for more than one allowance, the taxpayer can choose which allowance to use.

For many ordinary qualifying purchases, AIA may still produce:

100% IMMEDIATE RELIEF

and therefore be more attractive than claiming 40%.

But the 40% FYA can be valuable where:

• AIA is unavailable;
• AIA has already been used;
• the asset is acquired for leasing;
• the purchaser is an unincorporated business that cannot use full expensing;
• or another first-year relief is unavailable.

So the existence of the new 40% allowance doesn’t make AIA obsolete.

It gives businesses another planning option.

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Main Writing-Down Allowance – 18% to 14%

Where expenditure does not receive AIA or a First-Year Allowance, it may instead fall into a capital allowance pool.

The main-rate WDA is now:

14%

rather than the previous 18%.

The special-rate pool remains:

6%

There is also a transitional complication.

Where an accounting period straddles the April 2026 rate change, the business may need to calculate a hybrid WDA rate.

For example, HMRC’s own example of a company with a 31 December 2026 year end produces a hybrid main-pool rate of 14.99%.

So don’t automatically apply 14% to every 2026 year end without checking the accounting period.

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PCP – Contract Purchase

The original version of this article described PCP as essentially an HP agreement with a balloon payment.

That is a useful commercial shorthand, but the tax position needs to be more nuanced.

A typical PCP arrangement involves:

Deposit

↓

Monthly payments

↓

Large final or balloon payment

↓

Then the customer may:

buy the asset

or:

return it

or:

replace it

For tax purposes:

PCP DOES NOT AUTOMATICALLY TELL YOU THE ANSWER

The actual contractual terms need to be reviewed.

Relevant questions include:

• Does ownership automatically pass?
• Is there merely an option to purchase?
• How significant is the final payment?
• Who bears the residual-value risk?
• Is purchase expected in commercial reality?
• What happens if the balloon payment is not made?

So rather than simply telling your accountant:

“It’s PCP.”

give them the actual finance agreement.

That is particularly important where significant capital allowances are being claimed.

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Contract Hire and Leases

The original article correctly noted that contract hire normally does not transfer legal ownership to the hirer.

In a straightforward lease:

THE FINANCE / LEASING COMPANY OWNS THE ASSET

and therefore the lessee will not normally claim ordinary capital allowances on the underlying asset.

Instead, the business normally obtains the appropriate tax relief arising from the lease payments, subject to the relevant tax rules.

But there are important exceptions.

These can include:

• Hire Purchase and similar agreements;
• long funding leases;
• fixtures;
• and other specific statutory regimes.

So:

“It appears on our balance sheet, therefore we claim capital allowances”

is not necessarily correct.

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FRS 102 Lease Accounting Changed From 2026

This is one of the most important additions to the original article.

In March 2024, the Financial Reporting Council introduced substantial revisions to FRS 102.

Most of those changes are effective for accounting periods beginning on or after:

1 JANUARY 2026

The revised Section 20 – Leases moves FRS 102 closer to IFRS 16.

Under the previous rules, lessees generally classified leases as:

Operating leases

or:

Finance leases

Many operating leases stayed off the lessee’s balance sheet.

That position has now changed substantially.

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Most FRS 102 Leases Now Go on the Balance Sheet

For most lessee arrangements under revised FRS 102, the business recognises:

A RIGHT-OF-USE ASSET

and:

A LEASE LIABILITY

The accounts no longer simply show:

Rent expense

for many leases.

Instead, the P&L will generally include:

• depreciation on the right-of-use asset; and
• interest on the lease liability.

The balance sheet therefore reports both:

more assets

and:

more liabilities.

The cash payments may be exactly the same.

The accounting presentation is not.

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FRS 102 Example – £100,000 Piece of Equipment

Suppose Consultancy 4 Business Ltd enters into a five-year lease for a piece of equipment.

Under the old operating lease model, the accounts might broadly show:

Balance Sheet

No leased asset.

No lease liability.

Profit & Loss Account

Lease rental expense.

Under revised FRS 102, if the lease falls within the new recognition model, the accounts may instead contain:

RIGHT-OF-USE ASSET

representing the contractual right to use the equipment

and:

LEASE LIABILITY

representing the obligation to make future lease payments.

The ROU asset is depreciated.

Interest is charged on the lease liability.

So the accounts can look very different even though:

THE COMPANY HAS NOT BOUGHT THE MACHINE

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Does a Right-of-Use Asset Mean You Can Claim Capital Allowances?

This is the key point.

NO – NOT AUTOMATICALLY

Accounting and tax are not the same thing.

Under FRS 102, your business might recognise an accounting asset on its balance sheet.

But that does not itself make the business the legal owner of the underlying machine.

Capital allowance entitlement therefore needs to be determined separately.

You could have:

RIGHT-OF-USE ASSET IN THE ACCOUNTS

but:

NO CAPITAL ALLOWANCES ON THE UNDERLYING ASSET

because the leasing company remains the owner.

The exceptions — such as the HP and long funding lease rules — then need to be considered.

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Accounting Treatment ≠ Tax Treatment

This is worth remembering:

FRS 102 TELLS US HOW TO ACCOUNT FOR THE LEASE

while:

TAX LAW TELLS US WHO GETS THE TAX RELIEF

That distinction becomes much more visible from 2026.

A director may reasonably look at the accounts and say:

“There’s an asset on our balance sheet, therefore surely we own it?”

But a right-of-use asset is an accounting representation of the contractual right to use something.

It does not necessarily mean legal title has transferred.

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What About the Tax Deduction Under Revised FRS 102?

The move to right-of-use accounting does not simply mean tax relief disappears.

However, the tax treatment may not exactly follow:

depreciation

plus:

lease interest

as shown in the accounts.

The lease tax rules need to be considered separately, particularly where:

• the arrangement is a long funding lease;
• there is an option to purchase;
• the underlying asset has special tax treatment;
• or other specific leasing rules apply.

So don’t simply copy the FRS 102 accounting entries into the Corporation Tax computation without checking the tax treatment.

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Are Any Leases Exempt From the New FRS 102 Model?

Yes.

Revised FRS 102 provides recognition exemptions for certain:

SHORT-TERM LEASES

and:

LOW-VALUE LEASES

where the relevant conditions are met.

That means the new right-of-use model does not necessarily need to be applied to every small rental agreement.

But significant:

• property leases;
• machinery leases;
• vehicle fleets;
• warehouse leases;
• office leases;
• equipment leases

should now be reviewed carefully.

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Why Does FRS 102 Matter When Choosing HP or a Lease?

Previously, businesses sometimes viewed operating leases as attractive because they could stay off the balance sheet.

For FRS 102 businesses that distinction has now substantially disappeared for most leases.

So when comparing:

BUY

HP

or:

LEASE

consider both:

THE TAX RESULT

and:

THE ACCOUNTS RESULT

The new lease accounting can affect:

• reported assets;
• reported liabilities;
• EBITDA;
• operating profit;
• finance costs;
• gearing;
• bank covenants;
• credit assessments;
• and other financial ratios.

That could matter significantly where lenders or investors review the accounts.

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£100,000 Machine – Compare the Options

Let’s bring the position together.

Cash Purchase

Machine:

£100,000

Business owns it.

Potential:

• AIA;
• 40% FYA;
• full expensing where applicable;
• or writing-down allowances.

---

Business Loan

Bank lends:

£100,000

Business buys machine.

Business owns asset.

Potential capital allowances on the machine.

Qualifying finance costs considered separately.

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Hire Purchase

Machine:

£100,000

Deposit:

£10,000

HP finance:

£90,000

Ownership will or may pass.

Special HP capital allowance rules apply.

AIA or other allowances may potentially be available.

Finance cost considered separately.

---

PCP / Contract Purchase

Deposit.

Monthly payments.

Balloon.

Potential purchase option.

The tax treatment depends on:

THE CONTRACT

not simply the acronym PCP.

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Ordinary Lease

Finance company owns machine.

Business has contractual right to use it.

Under revised FRS 102, the business may show:

right-of-use asset

plus:

lease liability

but:

THAT DOES NOT AUTOMATICALLY GIVE IT CAPITAL ALLOWANCES

---

Long Funding Lease

Special tax rules can apply.

Although legal ownership may remain with the lessor, capital allowance entitlement can potentially move to the lessee.

This is a specialist area and should be reviewed separately.

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What About Cars?

Cars have their own additional tax rules covering:

• CO₂ emissions;
• electric vehicles;
• new vs second-hand vehicles;
• Benefit in Kind;
• VAT;
• lease rental restrictions;
• private fuel;
• and personal ownership versus mileage.

So the tax answer for a £100,000 machine should not simply be copied across to a £50,000 car.

If you’re considering a car, see our new guide:

Buy, HP, PCP or Lease a £50,000 Car Through Your Business?

It compares:

cash vs HP vs PCP vs lease vs personal ownership

including EV capital allowances, VAT, BIK and the 55p mileage rate.

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Frequently Asked Questions

Can I claim capital allowances on Hire Purchase?

Potentially yes. Special rules apply where ownership will or may pass to the business.

Can I claim AIA on Hire Purchase?

Potentially yes where the asset and expenditure qualify.

Do I have to finish paying for the HP first?

Not necessarily. HMRC confirms that once an HP asset is brought into use, capital allowances can take account of payments to be made under the contract, excluding interest.

Can I claim capital allowances on PCP?

Possibly. The agreement needs reviewing.

Who claims capital allowances on leased equipment?

Usually the legal owner, subject to exceptions including HP-type arrangements and long funding leases.

Does putting a lease on the balance sheet under FRS 102 give me capital allowances?

No, not automatically.

The right-of-use asset is an accounting concept. Capital allowance entitlement is determined separately under tax law.

What changed in FRS 102 from 2026?

For most qualifying leases, lessees now recognise a right-of-use asset and corresponding lease liability.

Can I still get tax relief for lease payments?

Potentially yes, but the tax computation should be checked rather than assuming the depreciation and interest accounting charges automatically equal the tax deduction.

What is the new 40% First-Year Allowance?

A permanent allowance for qualifying new and unused main-rate plant and machinery acquired from 1 January 2026.

Does the 40% FYA apply to cars?

No.

What is the main WDA rate now?

The main rate is 14% from April 2026, with transitional hybrid rates where an accounting period straddles the change.

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Before You Sign the Finance Agreement

Send your accountant:

• supplier quotation;
• asset description;
• purchase price;
• deposit;
• HP / PCP / lease agreement;
• finance charges;
• repayment schedule;
• balloon payment;
• purchase option;
• lease term;
• expected business/private use;
• and details of whether the asset is new or second-hand.

Because the difference between:

BUY

HP

PCP

and:

LEASE

is not simply how you pay.

It can change:

WHO OWNS THE ASSET

WHO CLAIMS CAPITAL ALLOWANCES

WHEN TAX RELIEF IS RECEIVED

HOW VAT IS TREATED

and now:

HOW THE ASSET AND FINANCE APPEAR IN YOUR ACCOUNTS

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Bicknell Business Advisers’ Advice

The best time to ask:

“How should we finance this asset?”

is:

BEFORE SIGNING THE AGREEMENT

not after the first payment has been made.

A £100,000 machine could produce very different tax and accounting results depending on whether it is acquired using:

• cash;
• business loan;
• Hire Purchase;
• PCP;
• finance arrangement;
• or lease.

From 2026, the combination of:

40% FYA

14% MAIN WDA

and:

NEW FRS 102 LEASE ACCOUNTING

makes reviewing the finance method more important than ever.

Can Your Limited Company or Business Pay for a Garden Office?

Buy, HP, PCP or Lease a £50,000 Car Through Your Business?

About the Author

Steve Bicknell FCMA, CGMA is Managing Director of Bicknell Business Advisers Limited, specialising in property taxation, landlord tax planning, SDLT, Capital Gains Tax and property company structures throughout the UK.