A "best" time to replace a fleet?
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ALL VEHICLES have a limited life, and operating costs increase as vehicles get older. Replacement policies were set against this fact, and many formulae have been justified and many words written in support of numerous "acceptable" policies, Most replacement policies have been based on the fact that as the maintenance costs increase annually, the capital depreciation costs of the vehicle decrease. it is at a point where the sum of these two costs is at the lowest, that a decision to replace would have been taken.
Example: 1: Lorry (D1314) purchased 1978 — cost £9,000. Depreciation rate of 30 per cent annually on a reducing balance. Annual mileage — 30,000 (see Table 1, below).
The question is now — should the vehicle be replaced in the expectation of a high maintenance cost in 1983? Before any decision is taken, it is necessary to examine the equivalent costs of a new vehicle in its first year of use: Example: 2: — Lorry (D1314) equivalent to the one to be replaced — cost £16,000.
— same depreciation rate — same operating mileage (see Table 2, below).
Already it is clear that the first year costs of the new lorry will be higher than the old one — the increased burden of the depreciation at £4,152 (f4,800£648} is much higher than any savings possible on maintenance — in fact, maintenance costs of up to £4,853 (£5,500-£648) could be taken on the old vehicle before any savings on the replacement proposal would occur.
The second year of operation of the new vehicle (1984) will still carry a high depreciation cost and the maintenance costs will start to increase. All this has been due to the high inflation rate over the past five years, which caused the lorry manufacturers to increase prices by an average in excess of 16 per cent per annum. With inflation now below five per cent, if this rate can be held over the next five years, the old formula of "maintenance plus depreciation" may then hold good.
in the meantime, are there any other areas where one can justify replacing vehicles which are becoming troublesome? The answer is — YES — providing that the business is "profitable".
It is possible to manipulate a lorry purchasing programme so as to reduce the taxable profits of the business, and at the same time improve the "cash flow".
Capital allowances have a part to play in any plan to acquire assets, including lorries. Vehicle replacement policies are usually accepted as being concerned with "how frequently" vehicles should be replaced, rather than "when, during a company financial year" is the best time to replace.
Getting the timing of acquisition right can bring substantial tax benefits to even a medium-sized fleet. This is because "capital allowances" are set against taxable profits of the accounting period to which they relate.
The purchase of a lorry at a cost of E16,000 would make available "first year allowances" equal to 100 per cent of the capital cost, which can be set against the taxable profits for the year of acquisition. Example: 3 — Company year commences January 1,1983 — Vehicle purchased in January 1983 for £16,000 — First year capital allowances claimed for year ending December 31, 1983 — Capital allowances set against taxable profits for year ending December 31, 1983, and tax due for payment on January 1, 1985 — Tax bill reduced by £8,320 (52% of £16,000) Consider the effect of purchasing the same vehicle in December 1982 — as "the year of acquisition" falls in the company financial year ending December 311982, the taxable profits for that year would be reduced, and the cash flow advantage brought forward one yearto the January 2, 1984— all done by planning the purchase and delivery of the vehicle to be effective one month earlier.
The same reasoning applies to the disposal of the vehicle being replaced — if 100 per cent first year allowances had been claimed on this lorry when purchased in 1978 for £9,000 (Example 1), a "benefit" of £4,680 (52 per cent of £9,000) would have been received by the reduction of taxable profits for the year of acquisition. When this vehicle is sold, the total proceeds become "taxable" in the accounting period in which the disposal took place. Example: 4: — Vehicle purchased in 1978 for £9,000, and 100 per cent first year capital allowances claimed.
— Vehicle sold in December 1982 for £1,000 — this amount will be added to the taxable profits for the year ending December 31, 1982, which will result in an increase of £520 in the tax payment (52 per cent of £1,000) which becomes due on the January, 1,1984.
Consider the effect of delaying the disposal of the lorry until January 1983 — this delay of one month will move the year c disposal to the next financial year (1983), and the additional tax payment due on the proceeds of the sale will be deferred until January 1,1985 giving a cash flow improvemen benefit of a full year.
In the above examples, Corporation Tax has been taker at a level of 52 per cent but irrespective of whether the business is liable to Corporatioi Tax or the normal income tax payment, using the availability of the 100 per cent first year capital allowances in periods ol taxable profits can be an advantage when planning vehicle replacements.
Simple rules to follow are: — step up purchases and the taking delivery of vehicles in tho last quarter of the company financial year.
— defer disposal of vehicles until the first quarter of the company financial year.
— if the company is not liable to tax on profits or has trading losses: — defer the purchase of vehicle: until such time as taxable profit are available.
— if possible, dispose of surplw vehicles in "non profit years" ss as to set off the disposal proceeds against trading losseE Hire purchase of vehicles carries an additional advantage — under the present rules of "capital allowances", vehicles acquired under hire purchase agreements are eligible for the full 100 per cent first year allowance, even though only a single repayment installment has been made.
The cash flow benefits received from the reduction of tax liability at the end of the firs year of use of the vehicle can easily be in excess of the total hire purchase installments mad under the agreements — a method of vehicle acquisition financing well worth considering.
In a future article the whole subject of "Capital Allowances' and how they apply to all transport assets will be dealt with in more detail.
• By Frank Woodward