Financing business assets – a guide for SMEs
Businesses will have a continuous cycle of purchasing or investing in new assets – from IT equipment to vehicles, manufacturing plants to tools of a trade. There are many different ways a business can finance that investment.
Our Shaping your future research reported that a fifth of businesses plan to undertake major investment in new technology in the next two years. This investment will sit alongside further investment in the assets that a business needs to build and grow.
With the cost of investment often high, outright purchase is rarely an option. There are now many ways a business can fund those purchases, supported by a sophisticated asset finance industry.
Here is my short guide to the most common ways a business can finance new assets or refinance assets they already own.
Hire purchase, sometimes called lease purchase, will be familiar to most of us. It is a common way for businesses and, of course, individuals looking to buy expensive pieces of equipment with a view to eventually owning them. Payment terms are fixed over an agreed number of months. This remains popular with businesses with a predictable cash flow.
Assets purchased in this way will usually be shown on a company’s balance sheet with payments shown as reducing a liability. A company can claim capital allowances on hire purchases, offsetting expenditure against taxable profits.
A finance lease, sometimes called a capital lease, is effectively a rental agreement. As with hire purchase, a fixed monthly fee is agreed over a set time frame. The leasing company will own the asset and whilst it may be possible for the business renting that asset to benefit from a percentage on any future sale value, it will never own that asset.
Assets purchased under a finance lease are typically treated in much the same way as a hire purchase agreement with the asset being recognised on a company’s balance sheet. There is, however, one notable difference. Tax ownership remains with the leasing company which can claim capital allowances. The depreciation charge will generally be an allowable tax deduction for the company leasing the asset.
UK GAAP (FRS 102 or FRS 105) makes a clear distinction between operating leases and finance leases, based on an assessment of multiple factors. For example, operating leases tend to have a much shorter term, relative to the entire working life of that asset; and the total cost of an operating lease is likely to be much less than the fair value of the leased asset. Assets held under an operating lease, are not shown on a company’s balance sheet and the rental costs are deducted from profits. The tax treatment for an operating lease will follow the accounting treatment.
Where a company applies International Financial Reporting Standards (IFRS 16), almost all leases are recognised on the balance sheet by recognising a right-of-use asset and a corresponding lease liability.
Contract hire is used exclusively to finance vehicles and is valuable for businesses that wish to spread the cost of fleets without the cost of maintenance and upkeep. Costs are fixed each month based on the value of the vehicle, the anticipated mileage and its estimated future value. At the end of the hire period the vehicle is handed back.
Because these contracts do not typically transfer the risks and rewards of ownership, they are likely to be classified as operating leases for accounting purposes and the tax treatment will likely depend on the terms in the lease agreement, all will need to be checked individually.
Personal contact purchase (PCP)
A twist on the contract hire agreement; a PCP agreement provides the lessee with the option to purchase the vehicle at the end of the initial lease term for an agreed sum. The accounting can vary depending on the terms of the lease, resulting in either an operating or finance lease. Again, the tax treatment will depend on the terms of the lease.
Businesses can use assets they own to raise finance to purchase new assets. There are two straightforward ways to approach asset refinancing. The first is to use the asset as security on a loan. If the business defaults on that loan, the asset will revert to the funder.
The second, more commonly called asset-based lending, involves the company selling that asset to an asset finance provider and leasing back that asset for an agreed monthly sum. This releases capital to allow the business to invest.
The resulting lease will need to be assessed as either an operating or a finance lease. This assessment will drive the accounting treatment, with implications on the recognition or derecognition of the asset, and the new lease liability.
The tax implications of a sale and leaseback transaction are complex and the tax treatment will be dependent on the terms of the agreement. We would recommend you seek tax advice ahead of completing a sale and leaseback transaction.
Capital Allowances Super Deduction
The super deduction was designed to stimulate business investment in plant and machinery and will be available for qualifying expenditure incurred from 1 April 2021 up to and including 31 March 2023. The super deduction provides for 130% capital allowances on most new plant and machinery acquired by companies. The aspect that makes the relief ‘super’ is that the relief obtained is more than the expenditure originally incurred.
Where the accounting period spans 1 April 2023, the 130% rate will be apportioned based on the days prior to this date over the number of days in the period. If we use a 31 December 2023 year end as an example, the super deduction will be 107.4%.
Ensure you maximise this relief by accelerating any capital spend before the end of your next accounting period.
How we can help
Businesses looking at the financing or refinancing of assets will need to take into account a number of issues, including cashflow and tax. Not all routes will be appropriate for all businesses.
We have specialist teams that work alongside businesses to advise on financing business assets. If you would like support or guidance in this area, please get in touch. Alternatively, we have a library of helpful content to support businesses with their planning here.
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