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Is your farm machinery a ticking tax timebomb?

Mike Butler, agricultural partner at PKF Francis Clark, warns there could be a sting in the tail for farm businesses that have enjoyed tax relief when buying machinery – especially if tax rates rise.

For many businesses the purchase of agricultural plant and equipment has been an important option to help minimise their tax liabilities.

The availability of 100% tax relief for purchases up to £1m per annum in the form of the Annual Investment Allowance has often allowed a lot of agri-businesses, including farmers and contractors, as well as those in construction and haulage, to mitigate their tax liabilities completely by claiming complete write down of plant and equipment when machines are bought or replaced.

Whilst this clearly presents a short term cash flow advantage in terms of minimising tax payments now, there could be a sting in the tail. As we know, the Chancellor is under pressure to deal with the huge national debt incurred as a result of the coronavirus pandemic. If tax rates rise, either in the Budget or at a later date, many operators may find they end up paying back far greater levels of tax in the future than they have saved to date.

How might this happen?

Take a simple example:

If a partnership bought a machine that cost £100,000 and therefore reduced its profits by £100,000 that would otherwise have been taxed at the basic rate of 20% with 9% National Insurance, a total duty of £29,000 would have been saved as a result of that one transaction.

If the machine is later sold for £80,000, that original tax saving may partially be reversed because the £80,000 sale proceeds would then be taxed on top of other income in that year at the taxpayer’s marginal tax rate.

Now consider a situation where that marginal income tax rate has gone up from 20% to say 25%. We also know that National Insurance rates for the self-employed may well align with those for employees, and the Chancellor alluded to such a possibility early in the pandemic. That would take Class 4 National Insurance Contributions (NICs) from 9% to at least 12%, and if there is a further general rise in NIC to say 14% the total marginal duty rate in this example would rise to 37%. Consequently, in this scenario, the total duty on the machine sale would equate to £29,600.

In short, the depreciation of £20,000 would generate a tax bill of £600, or an effective tax relief at -3% and not the 29% first envisaged – in other words, the cost of owning the machine would be compounded by a net tax charge, even though the machine had lost value!

What if you aren’t planning to sell your machinery?

You may be thinking you are unlikely to see a reversal of previously claimed tax allowances because you aren’t going to sell all your machinery – right? Wrong.

Even if you were not going to sell all your machinery but simply slow the amount of machinery you buy – possibly because you bought more machinery earlier than planned to claim that initial tax relief – or the Chancellor were to start to restrict the allowances available on replacement machines, it is likely you will start to see this reversal take effect and increase your tax payments. This is because a lot of farm machinery is now written down to very low values, and in a lot of cases nil. In this scenario, any future transaction will have limited tax benefit, particularly when machines are part exchanged.

Take another example of an agricultural contractor with machinery that has a book value of £2m. In a lot of cases that machinery has been written down to nil for tax purposes and therefore that business is sat on a tax deferral timebomb of around £800,000 if they are in an unincorporated trading structure with a marginal tax rate of 40%. This tax timebomb could become all the more dangerous if tax rates rise. The resulting tax outgoings might be catastrophic for the business, unless the reversal effect can be mitigated through careful planning.

So what can you do?

One option is to limit the amount of tax relief claimed on deals now, but often businesses can’t contemplate paying more tax at this time if cashflow is tight. On the other hand, planning for future tax liabilities and being fully aware of how this might affect your business is critical, particularly for those operations that are machinery intensive and where significant tax relief on machinery deals has been claimed.

The Chancellor clearly sees the extension of the £1m Annual Investment Allowance through to 31 December 2021 as a help for businesses. However, in the long run it may be a hindrance and certainly he will be looking for those businesses that are profitable to contribute to repaying the incredible increase in our national debt resulting from this dreadful pandemic.

As always, take advice from your accountant and consider other options to mitigate tax rather than simply the accelerated allowances on machinery. Buying machinery has its place and every business should look at the merits of the machine deal itself and what it can deliver for your business rather than simply the tax relief it might give you in the short term.

Overall, you don’t get any more tax relief than what the machine will lose in value, and most farmers are desperately keen to make sure their machinery doesn’t lose any more value than necessary. As shown in the example above, the situation may be worse if tax rates rise and you could end up paying tax for the privilege of owning a machine. Therefore, the reality is your tax relief may become limited and you might be sitting on a ticking tax timebomb.

To discuss any of the issues raised here, contact Mike on 01722 337661 or email mike.butler@pkf-francisclark.co.uk

FEATURING: Mike Butler
Mike joined PKF Francis Clark as a partner in 2019, bringing with him nearly 30 years of experience in the profession. As an experienced senior… read more
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