Tips on navigating machinery finance options
© David Kilpatrick/Alamy Stock Photo Hire purchase is still the most common way to finance farm machinery, offering the ability to claim capital allowances and a full VAT reclaim at the start of the agreement.
However, machinery price inflation, along with uncertainty over future farm policy and other considerations, has meant more farmers are questioning the viability of buying, says Cathy Barrow of Devon-based Ward and Co Accountants.
See also: Business Clinic – tax advice on farm sale and machinery disposal
The flexibility of some finance routes can offer an advantage over ownership.
“Leasing and some of the other options are usually used where cashflow is more difficult,” says Cathy. “We haven’t noticed a big switch away from HP but there is more talk recently of using contract hire.”
The circumstances of each business will of course be different, but there are some common considerations when looking at finance options.
“If you’re looking for asset finance, it can be worth putting the business out to a finance broker to see what rates are available,” says Cathy.
“They have relationships with a wide range of asset finance providers, and might be able to get you a more competitive rate than is available from your usual sources.
“Having said that, although less so than in the past, dealer finance is sometimes still available at 0%, and a broker wouldn’t offer that.”
The market is becoming more complex and while offers of finance might have similar or even the same names, the terms and conditions vary widely, so everything needs to be checked.
Full cost calculation
When taking on finance, careful costing and comparing rates are obvious first steps, but also ask for the full cost over the life of the agreement and compare the options on this basis, suggests Cathy.
Her other tips include:
- Check the terms and conditions for fees and charges, especially in relation to late payments or ending the agreement before the full term has run
- While general wear and tear through normal use is usually allowed for in agreements where the user is not the owner of the equipment, some things may not be covered and damage is usually chargeable, so check the terms on this and question anything that is unclear
- The different options have vastly different tax implications, so it’s worth getting advice on this aspect, including on the timing of transactions.
Farm consultant Jamie Gwatkin advises a wide range of businesses and recommends a 10-year rolling machinery replacement policy. He points out that capital allowances are useful only if the business is making a profit.
“When cashflow is tight the inference is that machinery purchases will get pushed back.
“When the machine is reliable and working well, that’s fine, but if it’s older and out of warranty then keep a watch on it with careful costings.
“The policy shouldn’t be set in stone but if you push replacement dates forward, you don’t want to be in a position where you need to replace several big pieces of kit in the same year, so that means keeping everything under constant review.”
Hire or replace?
Depending on the circumstances, hiring can be a cheaper option than replacing a tractor.
Conversely, the low depreciation on an old, reliable tractor with low repair costs can work out cheaper than a short-term hire, says Jamie.
“A bespoke HP arrangement through a broker can be the best route to a favourable rate and terms, but try manufacturers and the usual bank routes too.
“Watch for balloon payments at the end of leases and, as with all sources of funding, look at the total cost. You’ll be quoted a flat rate and the annual percentage rate (APR).”
The APR includes fees and charges as well as interest.
© Tim Scrivener
Hire to buy
Some dealers offer a hire-to-buy arrangement.
For example, a drill could be hired from September and used through the winter and spring in the run up to the end of the farm’s accounting year (5 April, for example), on the understanding that it will be purchased once the new accounting year begins.
This shifts the timing of depreciation to suit the farm, with the hire charge being discounted from the purchase price. If the machine is not bought, the hire charge is due.
Tax tips
Amy Brown is director of agriculture and property at accountant Ellacotts. Here she sets out some common tax issues with purchasing and selling plant and machinery.
Machinery sales can lead to what is known as a balancing charge.
This is a tax charge which arises when an asset on which capital allowances have been claimed is sold and the proceeds exceed the tax written down value and there is no tax pool.
When replacing machinery, if there is a gap between kit being sold and the purchase of its replacement, you could have a balancing charge in one tax year and then not receive the allowance until the following tax year, impacting the cashflow of the business, says Amy.
Beware also of the rules on the timing of capital allowance claims on machines financed through HP.
The full allowance cannot be claimed unless the machine is brought into use in the year that the claim is made.
However, when financing machinery with a loan, or cash, the “brought into use” rules for HP purchases do not apply.
One final point in regard to the timing of capital allowances – if an asset is purchased outright, with no finance, the full allowance might not be available on delivery of the asset where delayed payment terms of more than four months are in place. In such cases the date of payment will become the relevant date for allowances.
Lombard is part of the NatWest Group and one of many providers of asset finance to buy or lease machinery.
Head of agriculture Rachael Watson sees HP as a flexible and simple way to finance large and small assets on fixed or variable rates with the option of keeping the asset at the end of the contract.
“The lending is secured against the asset; we don’t usually need additional security, so it should speed up the process,” she says.
Ownership and title are not the same thing, and this is an important concept to understand, points out Rachael.
“Conditional sale and HP products offer the customer a direct ownership route.
“Our customer would be viewed as the owner of the asset just in the same way that you would ‘own’ your own residential property.
“However, to lend monies to our customer to purchase assets, we need to create security in the goods and the way we achieve this is to ask the supplier to invoice ourselves, not the customer, ensuring we achieve title to the goods.
“You therefore do not own the asset until you have repaid the agreement in full.
“This is similar to the way in which a bank or building society mortgage would work.”
A conditional sale agreement is regulated by the Consumer Credit Act 1974 and gives certain protections not offered by other finance options.
Whether a customer is eligible for this type of agreement depends on the type of borrower and includes private individuals (borrowing any amount for personal use), sole traders, partnerships of two or three, and other unincorporated bodies borrowing £25,000 or less for business use.
Contractor comment
Tim Russon © MAG/Oliver Mark
Lincolnshire-based contractor Tim Russon, of P Russon & Sons, mainly uses HP to finance machinery.
“Once you’ve paid for it and if it is still running well without expensive repairs, that’s your cheapest time,” he says.
Keeping track of running costs is key, Tim says, otherwise the right machinery decisions cannot be made. In some cases that means hiring rather than owning.
“For example, if I want a tractor for eight weeks for the maize harvest, I can hire one at £800 to £1,000 a week, depending on spec.
“That’s costing me £10 to £15 an hour. The depreciation on a modern tractor is higher than that and I have no tyre wear, no service costs and no capital tied up in the hired machine.”
Frequent changes in government farm policy, alongside climate challenges and economic factors such as borrowing costs, also require increasing flexibility in a business, says Tim, who was Farmers Weekly’s Farm Contractor of the Year in 2020.
“We’ve tried to move away a bit from services that could be affected by policy changes. Also, it’s important to take advice on the tax implications of the choice of finance.”
Finance types
Asset finance
Most of the following come under the general heading of asset finance, where the asset is used as security.
Asset finance is relatively flexible and often arranged with sources other than the main overdraft or loan provider to the business.
Operating lease
Under this arrangement the machine is not owned by the user (the lessee).
Payments are usually due monthly to finance use of the machine or equipment, and agreements typically range from two to five years.
With this option you have a fixed rental over a fixed term and, as you will not own the asset, there is no resale value risk, says Cathy Barrow of Ward and Co Accountants.
It may be possible to fix costs further by adding a maintenance plan to the contract.
The lease payments are a business expense for accounting purposes but no capital allowances can be claimed and the machine does not appear on the business balance sheet.
VAT charged on the lease payments can be reclaimed. Administration fees will usually be charged for late payments and there are penalties for terminating early.
Finance lease
This method usually works on monthly payments, although they can be annual or seasonal, and would typically run between two and seven years depending on the asset.
With this option the interest rate can be fixed at the outset, and VAT paid as each instalment is made, avoiding a big up-front payment.
The machine appears on the business balance sheet with the obligation to pay shown as a liability and the asset depreciated in the accounts.
The finance payments will include a finance charge and a reduction in the finance liability, with the finance charge being deductible against tax.
The lessor retains ownership of the asset and can claim the capital allowances.
At the end of the term a further term can be negotiated, or the asset can be purchased by the lessee or sold to a third party and some of the sale proceeds refunded to the lessee.
The lessee is responsible for maintenance and insurance. Again, there may be charges for late payments and penalties for terminating early.
Hire purchase
This route usually requires a larger initial payment, which may be a deposit in the region of, say, 10% plus the full amount of VAT, followed by monthly instalments.
Payment schedules can be tailored to align with business cashflow, with a contract typically ranging between one and seven years.
Capital allowance can be claimed on the full purchase price at the outset, while the interest element is claimable as a business expense and the VAT can be reclaimed on initial purchase.
The machine is owned, maintained and insured by the purchaser.
Tax and timing are important – capital allowances can only be claimed on capital payments that have not yet been made if the machine is brought into use within the accounting year of the claim, so beware when considering off-season HP purchases such as combines, warns Cathy. Check the cost of terminating early.
Loan
A loan is straightforward and has the benefit of full purchase price capital allowances being available on purchase.
However, it may involve offering other types of security, so may be more complex than some of the other options and could incur higher arrangement fees and associated costs.
The interest element will be allowed as a business expense for tax purposes.
Tailor the repayments to the expected life of the machine in the business, says Cathy, and be aware that early termination is likely to incur penalties.
Contract hire
This option is a straight rental for an agreed period of time, usually more short term or seasonal, with servicing and maintenance generally included in the hire charge, although any non-standard repairs (e.g. collision damage) would not be included.
Contract hire may provide a good way of fixing machinery costs without long-term commitment, but check exactly what is covered under the maintenance contract, says Cathy.
Check for hours or mileage restrictions and be aware that the asset will need to be returned in a good condition – there may be penalties if it has not been looked after.