New farm kit: Is buying, hiring or contracting best?

We all love that faithful old tractor which plugs on day in and day out; but what happens when it finally takes its last gasp and needs replacing?

Do you go for a shiny new version on hire purchase? Extend the overdraft to purchase one outright, or simply opt for a contractor?

The choice will not just affect your capital outlay, it also has significant tax and farm management implications.

See also: NAAC farm contractor charges 2017-18

We spoke to several advisers to weigh up the alternatives.

Buying options

Starting point: compile a full budget

According to Ian Powell, managing director at The Dairy Group, most farmers will run their own fleet of vital farm machinery, with lesser-used equipment more likely to be hired or contracted in.

But even then the finances can vary significantly, so it’s vital to set up a full budget to ensure you are comparing like with like.

Tractor running costs and labour time are rarely properly costed in, but as there’s a bill to pay with contractors, that cost is always clear. When comparing the two, you must work out the budgets.

One of the simplest ways to work out comparable depreciation on a straight purchase is to look at how many hours the outgoing tractor has done, compared with the number of hours on the new tractor.

Work out the difference between the two and calculate the cost an hour; a good target is below £5/hour.

On top of that will be interest or finance payments, fuel, repairs and labour, which should be included at realistic rates. In total, a typical farm tractor and driver is likely to work out at about £30/hour, says Mr Powell.

Another important consideration is cashflow and tax. Machinery replacement should be planned over a five-year cycle.

Look at what will need replacing next based on the economic life [depreciation versus repair cost] and make use of five-year profit averaging to maximise tax relief.

Buying

There are two key questions to ask when buying equipment: Is it vital and can it pay itself in five years? If the answer to either of these is no then you should look at alternatives.

Of course, when buying a new tractor or machine there are a few different options, which have different implications for capital outlay and tax (see “Finance options and tax implications”).

It can be difficult to weigh up the benefits of replacing an older tractor that’s starting to involve the cost of regular repairs.

The most critical thing is to keep a written account of what it’s costing. If maintenance costs and depreciation are higher than a replacement or contractor then it’s clear you should not hang on to the machine.

Hire purchase

Probably the most common choice right now is hire purchase, as there are some attractive 0% finance deals around.

Hire purchase spreads the cost, while buying outright is likely to require an overdraft or loan extension due to the high capital requirement up-front.

Hiring

Another alternative, particularly for equipment that is used less often, is to hire it. This is a useful option when you have the labour but not the machinery.

It may be that you only need the kit for a short period of time, so hiring – providing there’s no minimum term – could offer the most cost-effective solution.

Hiring can also be useful when trying out new machinery, enabling you to compare different brands and specifications without being tied into one or another.

You can also opt for a larger piece of equipment than you would normally buy, speeding up operations, with the knowledge that wear and tear is not your problem.

Contracting

A more common choice at busy times, or when operating under a short-term tenancy or contract management agreement, is to hire a contractor to do the job for you.

One advantage is that contractors often have specialist machinery that is used for short periods, such as forage harvesting and drilling.

The key with contractors is to work out the financial cost as well as the time savings.

You might think that buying a forage wagon is cheaper than using a contractor with a self-propelled forage harvester, but you need to consider the speed of the operations and the effect on silage quality.

A contractor with a self-propelled harvester could cut 40-60ha/day against 10ha with a forage wagon, and when rain threatens, that extra speed could be invaluable in terms of silage quality.

A reliable contractor is worth paying extra for – and if their equipment breaks down they are likely to have a backup to hand. However, in some cases they may be too busy to cope with different clients in a tight timeframe, which is when having your own equipment – or hiring it – can be useful.

Whatever you choose, you always need to have a contingency should the machinery break down.

Extended warranties are usually standard on new machinery – providing you service it regularly with the supplier.

Joint ventures and ownership with neighbours

Before considering how to fund machinery, every farmer should consider joint ownership and sharing with a neighbour, says Gary Markham, director at Land Family Business.

While common in the arable sector, the livestock sector is many years behind in embracing machinery joint ventures.

There is a lot to be gained – for example, a machinery-sharing syndicate could be linked to a share-farming structure between several dairy neighbours.

Another important consideration when budgeting is the effect any investment will have on profits, says Mr Markham. “Look at the extra income that could be generated or costs that could be saved, and weigh that against the investment that you’re making.” It is also important to include the tax relief in your budgets

He advises against buying a machine from cashflow unless it’s a minimal cost, and not to mix trading and cashflow budgets as they are completely separate things.

Finance options and tax implications

Hire purchase: Monthly payments to spread the cost may incur interest charges.

Tax relief of up to £200,000/year is available to offset against profits under the annual investment allowance (AIA) – but machine must be brought into use before the end of the business’ financial year.

Any expenditure over the £200,000 threshold is written down at 18%/year. Tax relief is available on the interest, but not on the capital element of the repayments.

Hire and contracting: Payments can be immediately offset against trading profits.

Loan or overdraft for outright purchase: Lump sum payment required. Tax relief of up to £200,000/year available to offset against profits under the AIA.

Any expenditure over this threshold is written down at 18% a year. Tax relief is also available on the loan interest payments.

Part-exchange: If selling or part-exchanging old machinery you’ve already claimed tax relief on, you could crystallise a taxable profit – check before making any decisions.

If part-exchanging, AIA is granted on the full value of the new machine, not the net value after the part-exchange.

A point on profits: Offsetting expenditure against tax is only useful if the business is actually making a taxable profit. Consider using five-year averaging to carry tax relief back or forward to offset against profits in different years.

Pros and cons of purchase v hire v contracting

 

Hire

Purchase

Contractor

Depreciation

No

Yes

No

Repair costs

Not usually, but may depend on who’s at fault. Tractor hours likely to be restricted

Yes

No

Insurance

Depends on agreement

Yes

No

Labour & expertise

Yes

Yes

No

Pros and cons summary

Need skills and labour to operate machinery but good if you only need it for a short time. Enables you to try out latest kit.

This should include kit that’s vital so you don’t need to rely on others to get the job done. You should have the expertise to use it and be able to pay it off over five years.

A contractor will generally save you time and can provide specialists expertise and the latest equipment (depending on who you use), which can make the job more efficient.

Examples of machinery

Topper, sprayer, trailing shoe, baler

Main tractor, quad bike, trailer, muck spreader, plough, drill, forage wagon, fertiliser spreader

Combine, grain trailer, hedge trimmer, forage harvester