A common scenario; you’re approaching your year end, you’ve had a profitable year. Your accountant tells you that you’re looking at a not insignificant tax bill.
Action: time to buy some assets?!
Your accountant might even blindly agree.
Say you purchase [insert desirable shiny new asset(s) here] at a cost of £75k, you’ll save tax of between £14k and £35k, depending on your business structure and other taxable income.
Brilliant. After your tax savings, the cash cost of that asset has now come down significantly, and is between £61k and £40k.
Even better still, you can opt to buy the asset on finance. The money you had previously set aside for your tax bill can now just be used for the deposit, and the remaining payments can be settled later.
Sorted.
If only it were that simple.
Nice to have
Sure, shiny new assets are nice to have. A new fleet of vans might give the workers a short-term boost, and might even be the envy of your competitors for a week or two (if they're that way inclined).
Wanting nice things is a very natural human desire.
It’s very common for businesses to justify ‘nice’ purchases on the basis that it ‘saved £XX,XXX in tax’.
In fact many accountants will be happy with this outcome too, as their tax-saving clients can go and tell their peers “my accountant saved me £XX,XXX in tax” – this might bring more business that accountant’s way.
There is always a cash cost to this apparent tax saving.
However, let’s take a closer look at one sentence above. Restructured, it could read:
The cash cost of that asset . . . is between £40k and £61k.
Herein lies the key point; despite the headline ‘saving’, your business is still having to spend between £40k and £61k. Regardless if it’s all paid upfront, or the payments are delayed through finance.
There is always a cash cost to this apparent tax saving.
Commerciality
Before committing to purchase, it’s vital to ask yourself; “what return will I get from this asset?”
If the answer is purely the tax-saving, it’s probably not a wise purchase – regardless of how much you might like to have it.
Would you hire them?
If we think about this in human terms, consider this:
You interview a potential new member of staff. They’re funny, good looking, and generally seem really likeable. Their CV shows that they’re not qualified to do the work your business does, and more importantly they probably don’t even have the capacity to learn how to do it. Day to day, they might become a bit of a burden (both in time and financially), but your staff would probably have a great laugh just by working in the same room as them.
Would you hire them?
The answer is probably (and hopefully), ‘no’.
In the case of our human assets - our personnel – we all instinctively hire based on the commercial return that each person will bring to the business. Should their performance subsequently deviate from that, they might lose their job.
So would it not make sense to approach the purchase of non-human assets with the same mindset?
buying an asset which gives a positive return . . . makes commercial sense
Assessing the return
Returning to the £75k asset above; if it will only bring in net cash income* of £6k per year (through time savings, cost reductions, etc), and will last for 8 years – it earns a total of £48k.
In other words, we can see that it actually loses £27k over its lifetime.
*Net cash income here is gross income, less the running costs which will be incurred. This also assumes the asset has no resale value at the end of its life.
Whereas, if the same asset were to make £18k per annum over the same 8 year lifetime, it stands to earn £144k – nearly double its original cost. From a cash perspective, it pays itself back in just over 4 years. Or from a finance perspective, it more than comfortably covers the ongoing repayments.
The initial tax savings of the two options are the same, but in buying the asset from example two, you end up comparatively £96,000 better off.
Clearly, buying an asset which gives a positive return like the latter makes commercial sense.
Consider the whole picture
Of course, there are many other factors which must be factored in when purchasing assets – such as the ongoing cost of existing assets due for replacement, technological and industry requirements, fluctuations in profit and the tax brackets you’re sitting in, current reliefs available/changes proposed to those reliefs, etc – and this is where a useful discussion with your accountant would come in.
However, the base consideration always remains the same:
Is the purchase of the asset commercially viable, and how exactly will it help your business?
As we can see, tax is just small piece of foil entwined in the business nest.
