Financing a used tractor purchase can be a tricky decision, with big tax implications. Mick Roberts asks Grant Thornton‘s director of agriculture, Gary Markham, for some advice.
While there is little to challenge the tractor manufacturers’ special, often 0%, interest rates for new tractors, buyers of second-hand machines need to look carefully to find the best finance option to suit their business, income, tax liabilities and cashflow.
Is it a good time to buy a used tractor, given the financial uncertainty?
Yes. While a business should never invest in equipment purely to “save on tax”, farms that are making a profit currently face some high tax liabilities from the good harvests of the past two years.
Some of these tax liabilities can be reduced by offsetting the cost of equipment. First there is the Annual Investment Allowance, which allows the first £50,000 of plant and machinery investment to receive 100% relief in the first year. It cannot be carried forward to the next year, so use it or lose it.
On top of this there is also a temporary 40% first-year allowance, which is in place until April 2010. If you are looking to invest in equipment, now is a good time to take advantage of this tax relief.
But, there may be reasons not to buy. Arable farms not only face high tax bills from recent harvests, they also have to fund expensive variable costs associated with the 2009 harvest, along with having much shorter credit terms from suppliers.
So, while tax-wise it is an ideal time to invest, farms should look carefully at whether they have the working capital to spend on equipment, meet their tax liabilities and have enough left over to pay their variable costs.
Isn’t it better to buy a machine rather than give it to the tax man?
New or used farm machinery should preferably be bought as part of a capital budget plan, which looks at the total investment required for a five-year period or longer.
A typical arable farm should plan to reinvest about £80-90/ha every year. By drawing up the plan, and sticking to it, you are able to spread the cost of all the machinery across five to eight years. This ensures the fleet is kept up to date and you have the funds in place to replace “big ticket” items. The plan also means you don’t have to replace a mainline tractor and harvester in the same year.
I need to replace a tractor now. I’ve seen a couple of likely candidates – a 2006 John Deere 6920S for about £39,000 and a 2006 Massey Ferguson MF 6480 for £32,500. How can I use these tax allowances when I finance this purchase?
In the first year you can offset 100% of a £50,000 investment as well as 40% off any remaining balance. If that tractor is your only purchase then the entire cost can be offset using the Annual Investment Allowance.
But the farm is likely to have made other purchases in the same period and these, along with the tractor, will be part of a “pool” for tax purposes. To make things simple to calculate assume this year’s pool comes to a total of £100,000. In year one, you can use your £50,000 AIA, plus the 40% temporary First Year Allowance. In subsequent years the remainder can be offset against tax using a 20% reducing balance.
How do I calculate these figures?
A fairly simple example using our £100,000 total “pool” is as follows:
Year 1: £50,000 (AIA), plus 40% (FYA) off the remainder (£50,000 x 0.4 = £20,000). Balance: £100,000 – (£50,000 + £20,000) = £30,000.
Year 2: 20% off the reducing balance. £30,000 – 20% (£30,000 x 0.2) = £6000. Balance: £30,000 – £6000 = £24,000.
Year 3: 20% off the reducing balance. £24,000 – 20% (£24,000 x 0.2) = £4800. Balance: £24,000 – £4800 = £19,200.
And so on
Is the 20% reducing balance the same as depreciation?
No. The ways you calculate depreciation for farm accounts and the tax allowances are different. True depreciation is the new cost of the machine minus the eventual sale price, divided by the number of years it has been owned.
Figures of 15% for tractors and combines, 20% for implements and 25% for other vehicles are realistic, which average to about 18% for the entire machinery fleet. This is the amount of money to be taken out of the business each year and used to buy planned replacements.
Can I use finance to pay for the machine as I use it over, say, three years for a used tractor?
Yes. This is entirely practical and feasible, particularly now interest rates are at an all-time low.
What about buying it for cash or funding it from the business overdraft?
No, that’s not such a good idea. It’s best to retain cash and the overdraft to finance the farm’s variable production costs. Also, the overdraft will be a variable interest rate, currently 1% or 2% over base, but by using a finance scheme you can lock into today’s low interest rates for the entire period. Also it’s best to retain the overdraft facility to fund other, possibly unexpected, opportunities or costs.
The tractor cost could push the facility to the limit just at the wrong time and to extend it will incur arrangement fees and other costs.
What about hire purchase?
With a hire purchase agreement the finance company retains ownership of the tractor until the final payment. There is seldom ever an arrangement fee and you can lock into the initial interest rate – currently about 5% to 6% – for the entire period. You should never finance a machine for longer than you will have it on the farm and I suggest that should be no more than three years for a four-year old used tractor.
Although you don’t technically own the machine, you do gain all the same tax benefits as would if you purchased it outright. This is why hire purchase is a good way to finance equipment.
Will I need to pay a deposit for a hire purchase?
Usually the agreement will include a 10% deposit, in a “3 plus 33” plan that will involve three month’s payments up-front, followed by 33 monthly payments. With a £30,000-40,000 used tractor the deposit required will be £3000-4000, which will probably be the value of the trade-in if you wish to use that.
How does this differ to a contract hire arrangement?
Contract hire is not usually available for used equipment. In this agreement you have the use of the machine for a set period and pay the finance company a “rental” for that time and use. At the end of the period the tractor is returned to the finance company. In most cases this will also include a service and maintenance contract for the machine.
The beauty of this is that you know the exact costs and there will be no large unexpected repair bills. You can also negotiate a deal where you buy the machine at the end of the period. With contract hire you are able to set the deposit and all rentals against trading profits for tax purposes, but you cannot claim the tax allowance as illustrated above.
Is leasing a good way to finance a used tractor?
No. I don’t recommend leasing because the finance company buys the machine and then rents it back to you for a set period. The farm never owns the equipment and therefore doesn’t benefit from any residual value. The finance company claims all the tax allowances for the equipment. You can offset the rental payments against your tax liabilities, but only over the useful life of the asset as opposed to when you pay the rentals. The sting in the tail of leasing is the sale of the tractor is a rebate of rentals and fully taxable.
Is short-term hire a better option than buying if the tractor will be mainly used during harvest and autumn cultivations?
The benefit of hiring is that you usually get a fairly new machine, which will be equipped with the latest technology and you don’t have to worry about breakdowns or paying for repairs. Short-term hire payments can be offset against tax.
The hire charge for a normal 12-13 week period is often similar to the annual hire purchase payment over a three-year period. But, unlike the hired machine, in this case you own the machine at the end of the period and benefit from its residual value.