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THE BOGY OF HIRE-PU1 :HASE PAYMENTS

23rd January 1942
Page 34
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Page 34, 23rd January 1942 — THE BOGY OF HIRE-PU1 :HASE PAYMENTS
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Which of the following most accurately describes the problem?

As I thought it would be, so it is. Several readers have written, and some have told me, that in my previous contribution I wrote that there were ways and means of dealing with the problem of hire-purchase instalments, so that they should not be so great a burden in a year, or years, when profits-out of which I insist hire-purchase instalments must be paid-are low. Others have written insisting that hire-purchase instalments are most emphatically to be included as operating costs, or at least working expenses.

Most interesting of all, I have had a letter from one of the association secretaries who tells me he is taking up the point with the local inspector of taxes, with a view to obtaining that official's acquiescence in the inclusion of these instalments in the hauliers' budget of expenses, so that tax need not be paid on the amount involved. As„the issue raised is novel, as well as being of widespread interest, I will deal with that first. ..

Can Hire-purchase Instalments Rightly Be Considered as Rental?

The argument produced by this secretary is briefly this. The hire-purchase instalments are, in effect, rental, being payments for the hire of a vehicle which, during the period over which the instalments are paid, is not the property of the haulier, but is owned by the finance company with which the hire-purchase contract was made.

The circumstances differ in no way, he insists, from any . . other contract of hire, and it is only when all charges have been paid that the vehicle becomes an asset and a capital charge. He would like to know whence comes the authority to classify these hire payments as capital and not current revenue expenditure.

The first thing that occurs to me, apart from the legality of the view expressed, is that if my correspondent's view be correct, a considerable revision of the method of dealing with the accounts of finance companies is going to be necessary. At present, presumably, the gross revenues earned by these concerns are derived from the 7f per cent. or nominal rate of interest which is paid in respect of hirepurchase transactions. (I use the expression "nominal rate of interest" because, of course, the actual rate is much higher than 7f per cent.) From that gross revenue is deducted the working expenses of the company, which pays income tax and excess profits tax-if any-on the balance.

If the method of assessing the revenue and expenditure of the haulier is to be that suggested by this association secretary a different state of affairs will come into existence, so far as the finance companies are concerned. All the payments for hire of vehicles will then become revenue, and subject, after the deduction of expenses, to taxation, E.P.T., etc., in full.

The nominal profits, and the income tax, to be paid by these companies will be swollen and I imagine that some drastic revision of the methods of finan,cing hire-purchase transactions will have to be made. It is unlikely that these revisions will react to the benefit of the haulier, who is thus liable to find his new state worse than the present one.

Scheme that the Tax Inspectors Would Not Accept

Indeed, the more I look into this letter and the wellmeant scheme to relieve the haulier of some of the heavy burdens of income tax and E.P.T. which he has to bear, the less likely it seems to me that it will be acceptable to the inspectors of taxes. In many cases the haulier would find extraordinary relief to accrue.

Take, for example, the case of an operator who acquires three vehicles for the total sum of £1,200, that amount including all the finance company's charges. That £1,200 is, in effect, paid by him to the finance company, not in respect of the purchase price of the vehicles, but by way of hire, at the rate of 250 per month.

At the end of the two years, during which the operator has.. worked these vehicles very hard, their market value

is about £40 apiece, or £120 in all. They then become his property and ne enters them in his capital account at £120. (I am, of course, ignoring the present-day inflated prices which are being paid for -used vehicles.) He thus pays income tax on £120 every two years instead of on £1,200. Very nice, very tasty, -very sweet!

As to the correctness of ray view, that hire-purchase instalments must he a charge on profits, take this case as an estampie. An operator who buys three vehicles in this way will do so only if he is reasonably sure that he is going to be able to earn enough, over and above his working expenses, to pay the instalments and leave a little profit for himself. And, if earnings, over and above working expenses are not profits, then 1 do not know the meaning of the word.

Now to deal with the problem of paying hire-purchase instalments without suffering too much "out of pocket." In the previous article 1 showed, in relation to the operation of two vehicles acquired under a hire-purchase agreement for £1,500 each—to be paid over a period of -two years—that the actual profit earned over four years was £2,047.

On the other hand it appeared, from the statement drawn up by a haulier correspondent, that, at the mid of four years, this operator was actually out of pocket to the extent of £958. The Spires are reproduced herewith in Tables I and II. Table I shows the figures by which it is deemed to he demonstrated that the operator loses 4.953 in four years. Table II shows, in my opinion, the logical way to enter the hire-purchase amounts.

To make myself clear it will be necessary to give, in greater detail, the figures for operating costs, establishment expenses, net profit, mileage, etc., in relation to the two vehicles. Some complication is unavoidable, but I will keep the work as simple as 1 can.

It seems to be. assumed that the total work done by the vehicles is the same each year. The correspondent makes the point that the profit is reduced in the third year, and still further reduced in the fourth yeas, for the reason only that he turns to Government work, at the published Government rates, during the latter years.

Repairs • Depreciation •

Total Total : (Less •depeedation)

Figures for a Business Overburdened with Overheads

On that assumption the figures shown in Table III have been prepared. They are approximate only—admittedly guesswork. They, obviously, relate to vehicles covering a high annual mileage, in a business .somewhat excessively burdened with overheads. The total is a convenient one; if the expectation of profit be accepted as 20 per cent. of the guesswork costs, that profit should be 42,124, which compares with the actual net prefit of 42,100 as shown in Table I. (The figure of £2,400 is taken, and not £8,000, because the amount of £900 for the salary of the three directors is included in" overheads.") Now, examine the first column of figures in Table those for the year ended April 5, 1940. There is shown, for that year, a loss of £603. Actually, as I demonstrated in the previous article and in Table H. there is no such loss. It is, nevertheless, a fact that the operator is, for that ' year, 4603 out of pocket. If he be short of capital that may be a serious handicap,* What 1 propose to do is to show that there is no need for it to be so.

Not all the items in the schedule of guesswork costs (Table III) are actual outgoings. The item " Interest " is a booking item wily. The operator does not pay it away; he merely, as is proper, debits it against his vehicles as a legiti

e 1.2.20 mate operating cost. There is £120 in £10,620 pocket.

The item "Depreciation," whilst

in no way comparable with that of "Interest," is, nevertheless, something with which the operator can juggle in order to offset his heavy outlay on hire-purchase instalments. The amount set down for depreciation is £600 per annum. That is, in effect, the amount which a wise operator will set aside annually towards the replacement of these two vehicles. In view, however, of his commitments on account of hire purchase, he may legitimately and wisely postpone the laying aside of that sum during the period—in this case two years— during which he is paying for the vehicle. He may, in fact, adopt one of two methods of dealing with this matter.

The Two Methods and What is Involved by Their Adoption

First, hal, may carry forward £600 per annum debit on account of 'that fund and liquidate the debit balance of

41,200 thus incurred dieting the remaining three years of the life of the vehicle. That will involve him in setting aside £1,000 per annum for depreciation during those three years.

Secondly, he may decide to ignore the debit, applying only E600 per annum during those three years. He will then have £1,800 available for the replacement of his

machines, and need incur only a hire-purchase commitment of 41.200 on their acquisition. Probably, in view

of the special conditions envisaged in this case, namely, the drop in profits during the third and, especially, the fourth and fifth years, this second method will be preferred. By adopting either procedure, he will have available, during the first year, a sum of £720 (£120 interest and £600 depreciation) to offset the out-of-pocket amount of £603 shown in the first column qf Table I, and the same amount to set against the deficit of £566 shown in the second column. '

In the third year, according to Table I. there is a positive profit of 4528, to which again may be added the interest, £120, making a sum of £648 available for distribution.

This " juggling " is perfectly legitimate and sound finance, having in mind the true position, as described in the previous article, and set out in Table IT, that the business has, in reality, made an average profit of £510 per annum. The real reason for the misunderstanding which has arisen is that the 41,500 is wrongly placed in the accounts. It should not appear in the statement of profit and loss, but in only the balance sheet, because it is an item of capital expense. S.T.R.

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