The UK Budget statement on March 19 brought several announcements with some relevance for asset finance. These were generally positive, although they come against a background of ongoing fiscal changes designed to scale back the large public sector deficit that opened up after the credit crisis in 2008-09.
Annual investment allowance
Among the most significant announcements by the Chancellor of the Exchequer George Osborne is an expansion of the annual investment allowance (AIA). This provides for 100% Year 1 tax write-offs for limited amounts of annual expenditure on any plant and machinery assets (except business cars) for each taxpaying business or corporate group.
AIA in its present form was introduced in 2008. It replaced an earlier scheme (dating from 1997) where similar 100% Year 1 write-offs were available without annual value limits to SME taxpayers defined by criteria of business size. The benefit of AIA is effectively concentrated on SMEs as a result of its financial limit, through there are no business size parameters for claimants.
From April 2012 the rate of AIA had been reduced to £25,000 per year, as part of a package of reductions in capital allowance (CA) rates to offset reductions in the UK corporation tax rate. However, that cut in AIA was reversed less than a year later, when the rate went up to £250,000, initially announced as for a temporary two-year period from the beginning of 2013, in a move to stimulate the then flagging level of UK business investment.
Now the temporary enhancement of AIA has been further increased, and its period extended. For expenditure incurred from the beginning of next month (or from April 6 for unincorporated businesses subject to income tax rather than corporation tax), AIA rises to £500,000 per year; and this rate is now scheduled to last until the end of 2015, after which it is due to revert to £25,000.
Where the tax accounting year of any business straddles the date of an AIA rate change, the AIA applies for that accounting year on a pro rata basis. Thus for those with calendar year accounting, the rate for 2014 will come to £437,500 (i.e. 75% of £500,000 plus 25% of £250,000).
Equipment purchases are not significantly encouraged by AIA in the case of most pure leases, where the lessee never takes legal title to the asset. For on these transactions in the UK it is normally the lessor who claims CAs; and though leasing companies are eligible for AIAs, these limited allowances will not be significant in relation to their annual lease portfolio inceptions.
For certain other asset finance transactions, however, where it is the lessee/ hirer rather than the lessor who claims CAs, SME customers will be able to make full use of their AIAs on equipment purchased on finance in the relevant year. Such contracts comprise:
• hire purchase (HP) and conditional sale agreements, where title is due to pass to the hirer at the end of the contract; and
• “long funding leases” (LFLs), which are pure leases running for over five years except for those with residual values of at least 25% not guaranteed by the lessee.
Responding to this announcement, Carl D’Ammassa, managing director of Aldermore Asset Finance said:
“Today’s doubling of the AIA provides much needed support for the five million SMEs across the UK. We have seen a number of changes to the allowance in recent years so this extension period provides some favourable conditions to boost investment in UK SMEs.
“The increase will allow businesses to bring forward investment plans and take advantage of the tax break. Aldermore is committed to supporting UK SMEs with their investment needs and is making over £750m in asset finance available throughout 2014.”
Other business incentives
The Budget announcements brought several other measures designed to stimulate business investment. These included two other extensions to special schemes for 100% Year 1 tax write-offs on plant and machinery, comprising:
• enterprise zones (EZs), where temporarily enhanced CAs for new expenditure in the few relevant designated locations, which had been due to last until March 31 2017, have now been extended for a further three years; and
• energy-efficient assets, where there are now two minor additions to the specified list of eligible machinery.
Lessors are precluded from claiming either of these allowances. As with AIA, however, they can be claimed by asset finance customers on eligible equipment funded through HP/ conditional sale type contracts or LFLs.
More significant Budget concessions for the business sector, although less directly relevant to asset finance, included:
• improved UK export credit facilities; and
• the reduction (or scrapping of previously scheduled increases) of several fuel and energy taxes and levies, including a capping of the “carbon price support rate” affecting power generation costs as from the 2016/17 fiscal year.
No new changes were announced to the corporation tax rate. However, as announced previously the rate will fall to 21% for the fiscal year starting next month, then to 20% from April 2015. The 20% rate is due to be one of the joint lowest among the G20 countries, although some smaller jurisdictions including Ireland have lower rates.
Specific new announcements on countering tax avoidance this time do not appear to include any measures directly affecting asset finance. Since tax changes that took effect in 2006, when the LFL rules were introduced affecting many big ticket deals for longer life assets, UK leasing has not been a substantially tax-driven activity.
Some technical anti-avoidance rules affecting limited areas of leasing or lease funding transactions nevertheless continued to appear each year until much more recently. For the time being, however, leasing transactions do not now seem to be perceived by HM Customs & Excise as a significant area for tax loopholes.
There was no new change to the Funding for Lending (FFL) scheme. This is designed to incentivize bank credit to SMEs (including leasing and asset finance) through Bank of England advances to the banks at small margins, geared to the incremental trend of the funded banks' advances to SME customers, above UK sovereign borrowing costs.
However, HM Treasury reported that banks' gross new lending to SMEs showed a 13% annual increase in 2013.
Commenting on the Budget announcements as a whole, Philip White, CEO of IT leasing specialist Syscap, welcomed the AIA increase but was critical of the absence of new initiatives on bank lending to SMEs. He said: “It is great that the Chancellor recognises that business investment is going to be one of the most important drivers of the economic recovery. Yet the temporary increase in the AIA only deals with half the problem. Banks are still unable to lend to SMEs on the necessary scale.”
“For many small businesses alternative funding, such as that offered by asset finance, can be a much more accessible source of the lending they need, to invest in their growth and make the most of the economic recovery. For the government to hits its targets for take-up of the AIA, it may need banks to refer companies that they cannot fund to more specialist asset finance providers.”
The fiscal and economic background
The overall fiscal stance of this year's Budget – i.e the year-to-year impact of changes in tax rates and allowances and in public expenditure levels – is broadly neutral. Substantial new tax cuts, including some in personal income tax, are balanced by net reductions in spending as part of a long continuing process of phased cuts since 2010.
After a long period of sluggish performance, UK gross domestic product (GDP) appears currently to be rising rather faster than in most other major developed countries. Estimated real growth of 1.8% in 2013 is officially forecast to be followed by further growth of 2.7% this year and 2.3% in 2015.
By the third quarter of this year, GDP is forecast to be back to its level at the pre-crisis peak in 2008. There is much uncertainty about the quantity of any remaining “output gap”. There is always assumed to be a long run growth potential, such that the absence of any net growth over the past six years should leave scope for growth above the long term trend in the coming years. On the other hand the “credit bubble” could have brought the level of output to an unsustainable peak in 2008 relative to the long run trend; the extent of the slump in 2009 could have done some lasting damage to productive capacity; and recent surveys suggest that some UK industrial sectors are now in fact operating close to their current capacity.
The volume of business investment, having fallen sharply after the credit crisis, now appears to have started a strong recovery. It is forecast to grow by 8% in 2014 and by over 9% in 2015.
What is clear is that the 2009 slump made a significant hole in tax revenues, and that the protracted fiscal adjustment process is only slowly bringing public finances back into balance. The capital value of UK national debt relative to annual GDP is now planned to peak at nearly 79% in the 2015/16 fiscal year, before starting to fall back.
This is not particularly high by international standards. However, the level of the UK's current public sector financial deficit remains much higher than in most other countries, although it is now falling steadily as the planned fiscal adjustments gradually take effect. The deficit was as high as 11% of GDP in the 2009/10 fiscal year. It is down to an estimated 6.6% in the fiscal year ending this month; and is planned to be down to 4.2% by 2015/16, with the possibility of the deficit being eliminated in five years' time if continuing public spending cuts were to take place as planned.
Against that background it is perhaps fortunate that some scope has been found for tax relaxations this year.