Your understanding is correct , as detailed in section 3.1 and 3.4 of VAT Notice 700/64:Motoring Expenses , the VAT incurred on the purchase of a qualifying car** with the intention of using it primarily for self-drive hire is recoverable in full. The same applies to cars primarily for use as a taxi or for driving instruction.
What many people do not realise is that a self-supply charge is triggered by non-qualifying use of a car on which a business has recovered VAT based on intended qualifying use.
HMRC have a trade agreement with the British Vehicle Rental and Leasing Association, which is detailed in Section 26 of VAT Notice 700/57: Administrative Agreements with Trade Bodies.
The agreement provides a simplified method which daily rental companies may use to calculate the VAT due on the incidental private use of their hire fleets, where cars are taken home overnight, or otherwise used privately, free of charge by directors or employees. The calculation is based on the list price of the car; full details of the simplified calculations can be found in section 26.
** A qualifying car is a car that has not been subject to the full input tax block. In other words, the business selling the car, or any previous owner, was able to recover input tax in full when they purchased the vehicle. In most cases the car when originally purchased will have been used for one of the excepted purposes detailed in section 3.1 of Notice 700/64, but a car used wholly for a business purpose, and not made available for private use will also be a qualifying car.
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