Accounting Matters
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Invest In New Assets

My business needs to invest in new plant and machinery in the coming year. However, we cannot decide whether to buy, hire purchase or finance lease the new assets. How does the tax treatment for each type of asset acquisition differ?

Outright purchase is often regarded as the simplest method of acquiring an asset. When acquired, the cost of the asset is capitalised in the balance sheet of the business and an annual charge for depreciation is shown in the accounts as an expense in the profit and loss account. The actual charge for depreciation, however, is not allowed for tax purposes, as this is replaced by capital allowances, which is HM Revenue & Customs tax deduction regime for allowing capital expenditure to be deducted from profits. Currently, the first £500,000 of expenditure by a business each year on plant and equipment, excluding cars, qualifies for 100 per cent tax relief. Also, any business that invests in energy-saving or water-efficient technology is entitled to claim a 100 per cent first year allowance. These are attractive tax incentives aimed at encouraging businesses to invest more in plant and machinery.

An alternative, but quite similar asset acquisition method, is Hire Purchase. A HP agreement usually includes an option to purchase the asset at the end of an initial period, at which time payment of a nominal fee transfers title of the asset and brings the legal agreement to an end. A HP asset is therefore treated for tax purposes as if it has been purchased outright. It is capitalised in the balance sheet and depreciation is provided on an annual basis and the obligation to pay future instalments is recorded as a liability in the balance sheet. Although the actual depreciation charge on HP assets is not deductible for tax purposes, HP assets also qualify for the favourable 100 per cent capital allowance tax reliefs, in the same way an owned asset qualifies for these reliefs.

The third acquisition method is finance lease. From an accounting perspective a finance leased asset is treated as if it had been purchased and it is therefore capitalised in the balance sheet and depreciation is provided on an annual basis. However, the tax treatment of finance leases differs considerably from outright purchase or hire purchase assets. Where accounts have been prepared in accordance with recognised accounting standards, the accounting treatment of finance leases is acceptable for tax purposes and therefore no tax adjustment to profit is required. Hence the depreciation charge is treated as a tax deductible expense. However, unlike acquired and HP assets, it is not possible to claim capital allowances on assets purchased under a finance lease contract.

Before deciding which asset acquisition method is best suited to your business professional advice should be sought.

The advice above is specific to the facts surrounding the questions posed. Neither PKF-FPM nor the contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.

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