Accountants are reputed and promoted in proportion to the amount of tax that their clients perceive they have saved them. In fact, it is not unusual to hear of farmers being advised how to save tax, even though they are not in a tax paying position. Recently announced changes to Capital Allowances highlight the best examples of this.
Firstly the Annual Investment Allowance (AIA) has changed. Until the 31 December 2018, a business can spend up to £200,000 a year on qualifying items (e.g. machinery, parlour, robots, bulk tanks, cubicles, slurry store) and write 100% of that investment off against its taxable profits. The October budget announced that from 1 January 2019, the allowance will increase to £1m; for many farmer,s the prospect of having enough cash available to spend £1m in one year is what dreams are made of.
The logic of the increased AIA is clearly to make businesses spend money to help the wider economy. Farming is a capital-hungry business and the latest increase in the allowance does little more than amplify the theoretical benefits on the tax bill of spending money. What has been lacking of late for too many is sufficient profit to pay for that investment – irrespective of any theoretical tax benefits.
The increased allowance will be an opportunity for manufacturers to sell and farmers to buy and of course simplistically it does feel better to spend money rather than pay tax – but sometimes it might be better to not spend it at all (especially if you haven’t got it to spend). If a farmer is in a tax paying situation, spending £100,000 on a new machine would save a basic rate taxpayer £29,000 in tax (or £19,000 if trading as a company) and so from a cash perspective, the business is still £71,000 (£81,000 if a company) worse off than if it hadn’t bought the machine. HP agreements disguise this fact by spreading out the cash impact.
We have had significant levels of AIA for some years now and most plant and machinery is consequently fully written off for tax purposes – the impact of this is that when a machine is traded in, its sale value is all treated as taxable income and so it is only “the cost to swap” that contributes to the AIA, not the whole purchase price of the new machine.
Of course ,successful businesses do reinvest and an element of capital expenditure is necessary and healthy; the best advice is to make certain the investment is needed and then assuming so, recommend the best timing of that purchase to maximise the tax benefits that arise. For example, if a farmer with a 31 March year end decides that it is right to change the mower for 2019, then it is probably going to be advantageous to buy it before 31 March 2019.
On a larger scale, the increase in the AIA is currently only available for two years until 31 December 2020 and so if a major strategic investment was planned for the next 2-3 years (parlour or team of robots for example) it is likely to be advantageous to bring it forward to make sure it happens before the AIA changes (unless of course it increases again at the next review). Again this is assuming that the invested business is going to be more profitable with the investment and if so, it will be able to pay less tax on those profits by making the investment.
On a technical note, with the AIA increasing on 1 January 2019, for farmers with December year ends this is straightforward, but there will be complications for other accounting year ends. For example if you have a 31 March 2019 year end, your AIA for that whole year is only £400,000 (see table) and there will be a cap for the period 1 April to 31 December 2018 of £200,000.
So for a farm with a year-end other than 31 December that is planning capital expenditure in excess of £200,000, the timing is crucial to maximise the tax relief. For example, a £400,000 investment in qualifying assets by a business with a 31 March year end, timed correctly, could achieve a tax saving of up to £188,000. However, if all the expenditure took place before 31 December 2018, the tax saving for 2018/19 would only be up to £111,000.
Investment plays a very necessary role in profitable farming and it can provide very considerable tax relief. The key to prudent investment is deciding whether it is going to make the business more profitable than it would be without the investment – if it is, then doing it in the most tax advantageous manner is certainly good advice. Businesses are vulnerable to poor investment decisions when only the latter aspect (tax) is considered, or if the two aspects (profit and tax) are considered in the reverse order – the winners are the ones that let investment be driven by profit and then seek to make that investment in the most tax efficient manner.