If January’s tax payment has taken a big chunk of your bank balance, you’ve probably already thought about trying to do something to avoid that sting again next year. Below we consider one of the most common methods used to reduce a tax liability and look at some other factors to consider before using it.
The common solution to reduce taxable profits and therefore your tax liability is to buy some machinery that will qualify for full relief in the year of purchase (expenditure covered by the Annual Investment Allowance) so that the taxable profit is much lower than the accounting profit made. Basically speaking, the higher the cost, the more tax relief you will get. However, before rushing off to order something new, there are a few other considerations to keep in mind.
Can you afford it?
You may have accounting profits, but profits do not necessarily equal cash. Before the purchase is made you should consider whether you have the spare income to meet a new finance liability and whether this money will be available for the full term of the finance agreement. It is also worth taking into account any future liabilities which may come around whilst you are still within the repayment period.
Do you really need it?
We all know that eventually the repair bills outweigh the benefit of keeping machinery. When this happens and that machinery is needed in a business there isn’t much choice other than to replace it. By this point there will be little part exchange or scrap value remaining on the disposal. However, if you are changing equipment often, any trade in value or sale of the equipment will create a value subject to tax in calculating your taxable profits. It will only be the difference in the cost of the new machinery and the part exchange value of the old equipment that will receive full relief so the tax saving may not be that large.
Is the tax charge as bad as you think?
In order to get tax relief for the new machinery, the full cost of that machinery eventually will be paid out by you, plus any interest on a finance agreement. It is worth considering whether in actual fact you would be better off just paying the tax which is likely to be a significantly smaller liability.
Is now the right time to buy it?
If you are thinking of spending money on capital items, it is worth considering when the best time to make that purchase is. Timing expenditure just before or after your accounting year end can have a significant impact on the tax you will have to pay.
Can you save up through the year?
Every employee pays over their tax liability each month as a deduction from their wages. If your tax liability feels like a big lump at the wrong time of year it may be worth putting aside money throughout the year to avoid having large sums to find. Once HM Revenue and Customs introduce Making Tax Digital it is likely they will look to start collecting Self Assessment on a more frequent basis so it’s not a bad idea to get into the habit of this more regular set aside before it becomes a requirement.
Can you use farmer’s averaging rules?
HM Revenue and Customs have special rules for farmers that mean the taxable profits of either two years or five years can be averaged out to create equal profits for those years. This could be used to save you tax without having to actually spend any money at all.
The whole situation needs to be assessed to ensure that it is a worthy investment. It’s definitely worth a quick conversation with your advisor to make sure it’s the correct decision and the timing is right to maximise the tax savings available to you.
There's more to consider than just buying machinery to save some tax. To ensure that its a worthy investment for you, get in touch with Kerryl Steel and maximise your tax savings.
