A common question from farming clients is, “why is my taxable profit different to my accounting profit?” There are a number of possible answers, but the most common one is the way the purchase of machinery and equipment is dealt with:
Capital allowances rules change regularly, but generally, give tax relief quicker than the depreciation charge. The consequence of this is that tax bills will fluctuate greatly and can catch out the unwary.
In recent years, most businesses have been able to claim 100% capital allowances on expenditure up to £1m each year. If a business spends the same amount on machinery each year, the tax payable will vary in line with the underlying profitability of the business. If however, a large purchase is made one year, and nothing the next year, then the taxable profit will bear no resemblance to accounting profit.
The biggest issue arises when a business had a low tax bill one year due to purchasing equipment, and then buys nothing the following year. There is more tax to pay in the second year, but this is made worse by the way Payments on Account are calculated. Being aware of the issue at an early stage at least means it doesn’t come as a nasty surprise later in the year.
In most cases, capital allowances are due when an asset is purchased, rather than when they are paid for. However, an asset bought on hire purchase needs to have been used before the end of the accounting period. For example, take a business with a 31st March accounting period that purchases a new mower in January. They will not be able to claim capital allowances on the cost financed by hire purchase until the following year.
When it comes to the tax treatment when assets are sold, well-maintained farm machinery holds its value really well, so the sale of second-hand machinery can fetch good prices. Where 100% tax relief was claimed when the asset was purchased, and there are no unclaimed balances, sale proceeds will be added to taxable profit.
For example, a business has traditionally used its machinery to make silage but decides to use contractors in the future. It, therefore, sells the equipment which for tax purposes is valued at nil. The proceeds are added to the annual profit, meaning there is a large tax bill. The timing of the sale needs to be planned carefully, and an averaging claim may be possible to minimise the rate of tax payable.
The position on a farmer selling up is similar to that on a change of policy. However, the tax problem can be larger because the proceeds are likely to be greater, and an averaging claim cannot be made in the final tax year of a business. Hence greater planning on the timing of the sale is needed to keep the tax bill down. The date of the machinery sale and the date final accounts are prepared for, can both impact the amount of tax payable.