5 March 2018
With seemingly ever-increasing farm machinery costs and pressure from the government for farmers to become more efficient food producers, farmers face an even tougher decision now on whether to expand or replace machinery pools.
Although tax planning is still seen to be a strong argument to replace machinery (see our previous blog – ‘Planning for the taxman’) there are many more factors to consider.
Just a few are:
- Common sense – What are the resale values? Is it even affordable?
- When it comes to key machines such as a main tractor, self-propelled sprayer or combine purchase, the intended useful life is important. The longer you intended to keep the asset the lower the depreciation cost per acre/ha. Changing too soon or holding machinery for too long can be costly.
- Where does the machine fit into the existing farming strategy? Most farmers favour a particular method of farming whether that be traditional plough and power harrow, min-till or no-till. However with more unpredictable weather, having a range of equipment allows work to continue when one method is not suitable.
Once decided, there are various financing options to consider:
Cash purchases would be the first choice for any buyer but few are fortunate enough to be in a position to make these.
When purchasing using cash you should consider the opportunity cost: what could the money be used for if you didn’t buy the machine? Could you develop that rundown building under permitted development rights and subsequently let it out instead?
Whilst a loan may be obtainable for such a development, finance for a machine is normally very easy to come by and therefore the cash option may be more suited to the development, leaving one of the below options for the tractor.
Hire purchases are the most common form of finance for farm assets. Although a smaller piece of kit could probably be brought using bank overdrafts, the higher interest rates will normally not make this sensible.
A hire purchase normally consists of an upfront payment of a minimum of the VAT amount, but more can be agreed if it’s feasible. Timing cashflows right shouldn’t be an issue as a great deal of farmers are on monthly VAT returns, enabling them to claim the VAT back shortly after purchase. There will be an agreed repayment plan for the remaining finance, payments for which are outside the scope of VAT so do not need to be reported on a return.
Capital allowance tax relief for a machine purchased in this way will nearly always be full relief at the purchase date, subject to availability of the annual investment allowance. Where this may not be the case is when the machine has not been brought into use before the accounting year-end. This most commonly happens when a combine is brought in March for a 31 March year-end. In this example the relief will be restricted to the amount paid off in the hire purchase agreement at the year-end. This will include the deposit, part exchange value and any monthly repayments already made.
Finance lease arrangement
A finance lease arrangement is similar to a hire purchase agreement in that the asset is treated as a capital addition in the accounts. However, legal ownership is not passed to you straight away. Lease payments are subject to VAT and should therefore be included on VAT returns. At the end of the lease you are normally able to buy the asset for an agreed amount.
There is normally a slightly larger initial payment followed by a reduced monthly amount. One cashflow advantage over a hire purchase is that initial payments are much smaller so if you’re submitting quarterly VAT returns where the delay between paying the lump sum and reclaiming it is extended, it won’t have such a negative impact on cashflows.
Tax relief is not given via capital allowances for finance lease arrangements which is contrary to hire purchases even though they are both treated as capital. Instead the depreciation charged becomes tax deductible. Depreciation is mostly charged between 15-20% on a reducing balance basis and therefore tax relief for assets purchased on finance lease arrangements is spread over many years rather than the year of purchase.
If the required machine is only needed short term or to cover periods of high demand, a straightforward lease may be the most suitable option. Income Tax relief will be via the monthly hire charges rather than capital allowances and VAT will be both charged and claimable on these payments.
If you’re in doubt about the tax or accounting treatment of any of the above finance options and would like professional advice, please feel free to speak to one of our rural and agricultural accounting specialists by clicking here. Alternatively, fill out our contact form and your nearest specialist will get back to you.