Stick or twist? Should you invest in your dairy business?
Many good business owners find that investing and growing their business is attractive, as it tends to build assets and grow net worth without losing much of the profit to the tax man. Rob Hitch, of Dodd & Co Chartered Accountants, considers what farmers should be looking at before investing in their business.
Investment often looks attractive as it can postpone tax charges, particularly for partners and sole traders who face the highest effective tax rates (see fig.1 below), especially at lower levels of income. The table below shows how high the effective rate of tax can be, taking account of entitlements to benefits.
Fig. 1. Effective tax rates (based on a family with three children)
So if there is anything that will create relief to avoid these punitive tax rates it certainly looks attractive. But if we are going to invest in the business what are the key considerations?
I always think that people do well at what they enjoy, so anyone committing to an investment in the business must have a passion for cows. We also need to consider the viability of any investment, so does it help to deliver a lower cost of production. I have for many years said that costs of production need to be at 25ppl or less, a point recently echoed by AHDB Dairy. In fact, the top 5% of producers are at 20ppl and less. As the DEFRA figures have shown, the last five and ten year averages are 27ppl, so costs need to be below this.
So what should we be investing in to make businesses more efficient and get a hand from HMRC through reduced tax bills?
Land & buildings don’t attract any tax relief, although some internal works can, but are generally the key building blocks of driving efficiency. That said you can purchase these assets using pensions, therefore attracting tax relief on the contribution to the fund. Advice should be sought as unwinding the pension at a later date might mean the land has to be sold. Another alternative is buying land in companies for those corporate clients, meaning a 19% tax charge on purchase rather than higher personal tax rates. That said the flexibility of owning land personally makes higher personal tax rates perhaps a necessary evil.
The next biggest investment is in cows, there are opportunities to create some tax relief on expansion of dairy herds depending on whether you are on a herd or trading basis of taxation. For anyone expanding dairy herds looking at what basis gives you the best cashflow position, i.e. minimising the tax bill is key. Remember there are also alternatives such as cow hire which will give you a deduction directly to the profit and loss account.
What most people think about when discussing investment, however, is spending on new infrastructure such as milking parlours, bulk tanks, silage pits, slurry stores, cubicles etc. which all qualify for allowances as plant & machinery. The current Annual Investment Allowance of £200,000 means that expenditure on these assets will attract full relief in the year they are purchased. Obviously, for those people facing effective tax rates of 70%, this is essentially the amount of money the government will contribute to your purchase! For companies, however, when you are only getting 19% tax relief the question of what the investment will deliver long-term is more relevant.
Remember if you are spending more money than the cash you generate then this will need to be borrowed, and repaid at some point in the future. In terms of demands, it should be noted that £2,000 per 10,000l cow needs 1ppl to repay over 20 years whilst the same debt on a 6000l cow needs 1.67ppl.
But do you need to do it all yourself, whilst joint ventures have been far more popular in grazing systems do contract/share farming or non-family partnerships provide opportunities to grow businesses by sharing the risks, and consequently the rewards?
Rob Hitch is a partner with Dodd & Co, leading a team delivering tax, accountancy and business advice to dairy farmers throughout the UK. He can be contacted at firstname.lastname@example.org