Your Money: Do your homework on PCs

The new workforce: you spend pounds 1,000 and the machine is out of date. Is renting better for the self-employed?
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Buying computer equipment is a headache for anyone setting up a home office. When cash flow may well be at its tightest, you are spending pounds 1,000 or more on something that is out of date almost as soon as you take it out of the shop.

The speed at which hi-tech equipment becomes obsolete, and the consequent fall in resale value, makes rental deals appear attractive; budgeting is easier and upgrading your equipment more cost effective. But the tax implications can be complicated.

Radio Rentals entered the PC market two years ago and now offers a range of deals under its Option 2 Own scheme. Its packages range from an entry- level refurbished 486 PC running Windows 3.1, at pounds 34.99 a month, to a multimedia Pentium P100 with Windows 95 and a range of other goodies. These include a CD-ROM drive, a built-in modem to use as a fax, answering system and to give Internet access, and pounds 1,000 worth of software. This deal costs pounds 54.99 a month.

You have to sign up for a year. After that, you can cancel the agreement, trade the PC in for newer equipment, or stick with it. If you keep the computer you will own the equipment after 39 monthly payments (another 27 months). Compared with the cost of buying outright, that of buying over 39 months is equivalent to paying annual interest (APR) of 9.9 per cent. The prices include delivery, installation and 39 months of on-site servicing. Radio Rentals also runs a dedicated computer helpline, with calls charged at a local rate, and offers a half-price deal on all its printers.

PC World, part of Dixons, started to develop its computer leasing operations last year. Under a typical deal, you make quarterly payments for three years and then have an option to buy the equipment for a nominal amount. Again you sign up for a year initially, and after that you can upgrade. More than 5,000 products are available on lease terms, including 75 different PCs and 20 different portables, among them hardware made by Apple.

The tax treatment of such deals will depend on the terms of the agreement and precise wording of the contract, according to Maurice Fitzpatrick, a senior consultant at Chantrey Vellacott, the accountants.

If the Inland Revenue decides that a deal qualifies as a rental or lease agreement, any payment can be treated as a business expense and, for the self-employed and those with freelance income, offset against taxable income. So for a higher-rate taxpayer, each pounds 100 of rental payment would in effect cost you pounds 60 (ignoring any additional ability to reclaim value- added tax).

You can only offset to the degree that you have freelance earnings, however. If you are employed and your earnings are solely pay as you earn, it is highly unlikely you will be able to get any tax benefit.

For people who do have the earnings, the position can be more complicated, and less advantageous, if the Revenue decides to view the deal as a hire- purchase agreement. In this case you will be treated as if you have bought the equipment from the start, and will only be allowed claim what are called capital allowances on the value of the equipment. This means you get tax relief on 25 per cent of the value of the equipment in the first year. That amount is then written off the value of the equipment, and you get relief on 25 per cent of the balance in the second year. It carries on like that each year, with the amount of relief progressively decreasing. On top of that, however, you get full tax relief on any interest deemed to have been paid. Nevertheless, the reducing value of the capital allowance is likely to make the overall deal less beneficial in tax terms than renting.

To confirm the tax treatment of a rental deal, Mr Fitzpatrick recommends checking contracts thoroughly, asking the retailer how previous deals have been treated and, if necessary, getting an accountant to go over it.

However, to get the full rental costs or capital allowances offset against taxable income, you must convince the Revenue that your equipment is used solely for business. That may be hard to prove and very unlikely anyway; there are bound to be a few private letters. Mr Fitzpatrick says you should be able to agree with the Revenue that a nominal amount of your costs, perhaps 10 per cent, will be disallowed.

Things get even more complicated if you are trading as a limited company rather than as a sole trader. If your company allows you as an employee to have private use of the computer, you can be taxed on what is known as a benefit-in-kind.