MARKET REPORT COMPACT PLANT
Re-thinking plant funding
EHN invites Nigel Greenaway, Marketing Manager at JCB Finance Ltd, to assess the impact of recent changes in tax rules on plant procurement.
The Annual Investment Allowance (AIA) lost much of its appeal from April 2012 onwards with the £100,000 tax write-off in the first year being reduced to just £25,000. To make matters worse, the reduction in the annual Writing Down Allowances (WDA) from 20% to 18% per annum stretched the period it takes to write off 90% of an asset’s cost against tax from 10 years to 12 years.
Faced with these dramatic changes to the tax rules, we need to ask whether there is now a more tax efficient alternative funding method that will allow faster write-off against taxable profits? The answer is ‘yes’ and it’s called operating leasing. In the plant and tool hire market, whilst hire purchase remains the most popular form of funding, a number of hirers have realised that they have a core group of machines that they plan to operate for a set period which are unlikely to be changed or disposed of before that period has expired.
This core fleet of machines could be written-off against tax far more quickly because, with an operating lease, 100% of the monthly instalment payments can be offset against taxable profits. If you run the machine for three years, 100% could be written off. For example, a hirer spending £125,000 on five mini excavators can see from the example below the tax treatment on the remaining £100,000 expenditure on plant, once the initial £25,000 AIA has been claimed. Financed over three years, it compares cash/hire purchase against an operating lease (3+33). The tax treatment of HP and cash is identical.
£100,000 Cash/Hire expenditure
Year 1 tax write off Year 2 tax write off Year 3 tax write off Total tax write off
Purchase £18,000 £14,760 £12,103 £44,863
Operating Lease
£33,373 £28,396 £23,663 £85,432
The Operating Lease offers 90.43% better tax write-off in as little as three years. The figures will vary depending on the make and model of machine and its respective residual value (RV).
Residual value conflict
The monthly instalments on an operating lease are usually considerably less than a normal hire purchase agreement because an operating lease reduces the total amount the customer pays by the future residual value (RV). The leasing company (lessor) will recover the machine and sell it at the end of the lease to realise this unpaid RV amount. A higher RV will lower the monthly instalments by a greater amount, but will increase the risk to the lessor.
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This potentially leads to a conflict of interests with the customer wanting lower monthly instalments, but the lessor wanting to minimise the RV risk of losses on sale of the asset. Traditionally, this is why a leasing company would be reluctant to reveal where it has set the RV for fear of being accused of minimising its own potential losses, which, in turn, would increase the customer’s monthly instalments.
A possible solution to these conflicts of interest is a new type of operating lease from JCB Finance. It has developed a new offering called JCB FlexiLease that has all the features and benefits of an ordinary operating lease. However, JCB FlexiLease overcomes the RV and profit on disposal issues by informing the customer at the outset of the agreement what the RV is - referred to as the Investment Value (IV).
In addition, any profit on the sale of the machine at the end of the lease term, which is greater than the original IV, is kept by the customer, who acts as a sales agent. Any loss made on the disposal, maybe because the IV has been set too high, is met by JCB Finance (the usual return conditions, excess hour charges, will apply, but only if required). This is a win-win situation for the hirer, which retains all of the reward, but takes none of the risk. JCB FlexiLease could prove to be a more attractive alternative to hire purchase or, even, the traditional operating lease. Ultimately, however, JCB Finance is not a financial advisor so an accountant or finance director will need to run the calculations to see what is best for the business, coupled to a sound reason for investing in additional plant and machinery in the first place.
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www.jcb-finance.co.uk
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