Keep the lights on with tax reliefs
It's not surprising that amid all the fears of energy inflation, driven in part by the Government's introduction of the carbon price floor last April, 60% of UK businesses are looking hard at ways to improve their energy efficiency this year, says Roger Skinner.
According to recent research, 88% of businesses say they are worried about the security of their energy supply. Although the Government froze the carbon floor in its 2014 Budget, the issue is very much here to stay.
These statistics appear in a recent report from the Major Energy Users’ Council, Powercut Britain: Are The Lights About To Go Out For UK Business? The report focuses more on cost savings than on improving environmental sustainability, but the two are of course linked.
Of all the options available to businesses, including investing in behavioural change programmes and on-site generation, upgrading to greener lighting systems might seem the quickest fix – and might also promise the best return on investment. After all, lighting accounts for on average a third of a building’s electricity use – a figure which hasn’t changed in almost 20 years, since the 1997 Kyoto Protocol.
Let’s say you’ve decided on an upgrade, for cost-saving and/or environmental reasons, and you’ve chosen an energy-efficient lighting technology. So far, so good. You’ve also locked down a specific lighting design for your building(s), which includes lamps, fixtures and controls, as well as choices concerning adjusting colour and intensity. Even better.
You might at this stage think you’re well on the way to saving up to 40% of your lighting energy costs, according to The Carbon Trust. But you might be mistaken, because you might not have given enough thought to how you are going to pay for it all. It’s easy to blow a significant amount of those potential cost savings on an inefficient financing model.
The leasing option
Take, for example, leasing: a popular tax-efficient option for most capital assets. A typical financial lease allows you to spread the cost over several payments so offers clear cash flow benefits. In addition, because payments are fixed, it helps when it comes to forecasting budgets.
Leasing also means that you won’t own the asset, which is sometimes the preferred approach. This is particularly the case with IT equipment, as it rarely holds any intrinsic value a few years after installation. However, this is possibly not the best option when upgrading to greener lighting systems.
LED lighting is often sold on its longevity, so leasing for an installation that may well exceed 10 years becomes less beneficial. Also, because you don’t own asset, you can’t take advantage of the government’s Enhanced Capital Allowance (ECA) scheme, which allows a business to offset 100% of the cost of investments in certain energy-saving equipment against any taxable first-year profits.
The Hire Purchase option
Being eligible for the ECA scheme doesn’t mean you have to incur major upfront capital costs. Instead, consider the good old-fashioned Hire Purchase agreement, which lets you spread installments while guaranteeing final ownership of the asset.
Let’s take an example purchase of £250,000 with an HP agreement spread over 60 months. You get the cash flow benefit plus, under the ECA scheme, you can offset the entire £250,000 against pre-tax profits in the first year. While it is always advisable to seek professional advice on your specific tax circumstances, it is possible to make some broad estimates.
Based on a 10% interest rate, your monthly installments would be an estimated £5,268. So, in year one, your total payment for the Hire Purchase would be around £63,216. However, because you can offset the total purchase price in the first year, you would also reduce your tax bill by £52,500 (based on a corporate tax rate of 21% where annual profits exceed £300,000). This means the net effect is equivalent to an outlay of just £10,716. If you lease, however, you wouldn’t get these enhanced capital allowances and, instead, you would only be able to offset the rentals paid.
These savings are particularly important when looking at your return on capital, which for some companies is as high as 15%. Return on capital is a way to measure how effectively a company is investing capital back into its business to generate returns. Having additional cash from the ECA scheme to do this offers clear advantages, allowing you to put it to better use in the business.
There are also other technicalities to consider. The lighting products must also meet the Government’s ECA eligibility criteria. While these are published online, it is worth confirming with the manufacturer, as guidelines are not crystal clear, given that products are not listed individually.
Traditional loans and cash purchases
It’s also worth considering the other available options to see how they compare. A traditional loan may be worth considering and is eligible for the ECA scheme. However, commercial loans of this size and for this purpose might be difficult to obtain without additional forms of security.
An HP agreement will help a business to leave its existing banking facilities intact by creating an additional line of credit, where the only security normally required will be the asset itself.
If you opt for a single cash purchase – and you pay corporate tax – you will also be eligible for the ECA scheme, you will own the asset, and you will benefit from the same operational savings from the technology itself. However, you won’t have the obvious cash flow benefit of spreading the cost as with the HP route.
So if you are one of the 60% of UK businesses planning a substantial investment in greener lighting systems this year (MEUC, October 2014), Hire Purchase might not seem the obvious choice. However, it’s a pragmatic solution that offers a triple whammy: reduced energy costs and carbon emissions resulting from a technology upgrade, the offsetting of 100% of tax on business profits in the first year, and a spreading of the overall payment to help cash flow.
Roger Skinner is the CEO of Maxxia, a provider of asset finance solutions
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