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Tax and business finance: getting the best outcome

As your retail business grows and expands, you will face choices as to how that growth is financed. In some cases, the business may be sufficiently profitable that future growth plans can be financed from internally generated capital. In most cases, it will be necessary to look to external finance in order to secure the funds your business needs to grow.

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Amongst the areas you might be looking to finance are:

  • The acquisition of new and bigger premises, or an extension to existing premises.
  • The acquisition of new equipment, fixtures and fittings.
  • Taking over competitor businesses through mergers and acquisitions.
  • Development of new product lines.

If you borrow money to finance the growth of your business, interest paid on that finance will generally be tax deductible, provided all the borrowed funds are used for business purposes (you’ll need to apportion the interest if some of the finance is used for private or domestic purposes).

Loan payments consist of two elements:

  1. the repayment of the principal, which is a capital expense and not deductible and;
  2. the interest element (cost of finance) which will be deductible where the loan is for business purposes.

Interest is deductible immediately even where the borrowed funds are used to acquire capital assets, such as property or plant.

Costs incurred when borrowing are also deductible by the business, as are the costs incurred when discharging a loan. These might include:

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  • loan procurement fees
  • guarantee fees
  • legal costs
  • stamp duty
  • valuation fees
  • survey fees
  • underwriter’s fees

No deduction is available if the finance does not go ahead.

In some cases, rather than borrowing money to fund the business, you may choose to tempt investors by offering them a stake in the business. So, instead of lending money to the business, you might give them an ownership interest in the form of shares, which will provide them with a share of profits going forwards. To do this, you must be trading through a company.

The issue of shares does not give rise to a tax deduction and the return on those shares – in the form of dividends paid to the investor – are also not tax deductible since they are paid out of after tax profits. Dividends are however frankable which means the investor is “credited” with some of the tax your company paid on its profits, which generally results in a reduced tax liability on the dividends compared to interest.

Financing asset purchases for the business

In many cases, you will want to raise finance to acquire new assets to use in the business, such as retail fit out equipment (which could include everything from shelves and racking to music systems and POS equipment), vans for transporting stock, new IT systems or plant and machinery to make products. In some cases, you will borrow money to acquire the asset from a bank or other financial institution (in which case, the borrowings are dealt with as above) and in others, you will lease the asset.

There are different ways to lease an asset. The distinctions between buying an asset using Hire Purchase (HP), taking out a finance lease and taking out an operating lease can be quite subtle but the tax treatments – and the legal obligations and responsibilities imposed on your business – can be very different, depending on which route you take.

Hire Purchase contracts

If your business acquires assets under a HP contract, you will acquire full legal ownership of the assets, subject to any security on the asset put in place by the lender.

For tax purposes, the following deductions for assets financed under a HP contract can be claimed:

  • the interest component of the HP payments
  • repairs to the asset
  • depreciation on the asset from the date of the HP contract

Finance Leases

If your business takes out a finance lease on an asset, your business will take on many of the risks and rewards of ownership of the asset without – initially at least – taking on legal ownership.  Typically, after paying the lease payments for the duration of the term, your business will legally acquire the asset by paying out the residual payment to the lessor. Until that point, the entity leasing the asset to your business will be the legal owner.

For tax purposes, lease payments made under a finance lease are immediately deductible. In addition, as your business will be responsible for keeping the asset in good order, any repair or servicing costs will also be tax deductible. Your business can’t claim the depreciation on the asset – the entity leasing the asset to you will claim that.

Operating leases

If your business takes out an operating lease on an asset, it is basically renting that asset from the leasing entity, which retains ownership of the asset.

In many cases, that can be an attractive option. Because the risk of ownership remains with the entity renting the asset to your business, you avoid any of the risks of obsolescence and don’t have to worry about maintaining the asset or repairing it if it breaks down, since the lessor is usually responsible for all those costs.

For tax purposes, payments made under an operating lease are immediately deductible in the period to which they relate provided the asset being leased is used in the business. As noted above, servicing and repairs will often be included in the headline rental cost but if charged separately, they will also be deductible.