What did the Autumn Statement do for us?

December 7, 2023

We’ve been looking into how recent changes to rules around full expensing might impact valuations.

The Autumn Statement is always a significant date in the diary. It’s imperative that we keep a close eye on any tax changes that might impact our valuations. The main thing that stood out to us in this year’s Autumn Statement was the announcement that full expensing is to be made permanent. The Chancellor made this decision to increase investment in the UK, which in Q1 of this year was the lowest of the G7 nations at 19.1%.

Announcements like this obviously have an impact on how companies will spend their cash and therefore on the accounts.  And accounts underpin all our company valuations.

Full expensing allows companies to deduct the full cost of capital equipment from their taxable profits in the year in which the purchase was made, rather than spreading the cost across multiple tax years. Now there is no minimum or maximum amount of investment that can be deducted, meaning that companies can claim full expensing relief on all qualifying plant and machinery investments. Examples of qualifying investments include lorries, vans, office equipment and warehouse or construction equipment and more besides.   Even service sector businesses can fully expense their laptops!

With Corporation Tax at 25%, the ability to write off the full cost of investments is equivalent to a tax saving of 25p for every £1 invested.

So that’s the theory, but, in practical terms, what happens to a company’s accounts if they claim full expensing relief?  Using full expensing reduces a company’s tax bill in the year it is claimed so this has a positive cash impact for the company in year one (less tax to pay), which is good.   However when it comes to accounting for this capital expenditure, it gets a bit more complicated.  We need to understand this so that we can not only understand the cashflows, but also the profit and loss account because both are used in valuation methodologies.

It matters because using an EBITDA multiple is a popular way to value a company.  It’s the D and A bits of this phrase which matter – depreciation and amortisation, particularly depreciation.

Full expensing is accounted for in a different way to what you might think.  You do not depreciate the asset you have acquired in year one even if you have claimed the full expensing allowance. You still apply the company’s depreciation policy (for example depreciation on a car might be four years) as normal over the period the policy has set.  That is great news for us.  The impact of Full Expensing does not affect EBIT and EBITDA!

However there is an impact on a company’s cashflow as it will have less tax to pay in year one. Equally in later years its tax bill may be higher than before the Chancellor’s announcement because it would have been charging a depreciation amount in each of the years over which the asset was depreciating.  In reality the tax is deferred not avoided.

It’s rare to value on net profits, but the impact of this reduced tax bill will mean that retained profits are higher and this can be important if we are looking at a company’s balance sheet as part of the valuation exercise (see more below0.  It may also have an impact on distributable profits available to pay dividends.

However we also need to remember that in future years, because all the tax relief was claimed in year one, thereafter the company will not be able to claim the tax relief again.  (Under traditional rules, the tax would have been slightly reduced over the life of the asset as set out in the depreciation policy).

From a technical perspective this is how to think about it.

Deferred tax arises because there is a difference between a company’s taxable profits and accounting profits. Companies claim tax depreciation when calculating taxable profits, but they deduct accounting depreciation when they calculate accounting profits. The value of the asset in a company’s accounts is called the carrying value and is calculated as (cost – depreciation). When calculating taxes, the asset is shown as the tax base, which is (cost – capital allowances). The difference between the carrying value and the tax base is called a temporary difference. In order to determine the deferred tax liability, the temporary difference is multiplied by the tax rate.

Here is an example.

ABC Ltd purchases £100,000 worth of computer equipment and the asset depreciates at a constant yearly rate of 20% over five years. The capital allowances available are 100% in the first year and 0% thereafter. If the tax rate is 25%, we will see the following:

It is important to remember that deferred tax is a notional liability that will never actually be paid. This means that, once it is set up, it is only necessary to adjust for the movement from one year to the next.

Perhaps the most significant impact full expensing might have on valuations is regarding the company’s net assets. By acknowledging a deferred tax liability on the book value of its qualifying expenditure(s), the company’s net assets less liabilities may be significantly lower than they otherwise might be.

It’s all a bit technical we know, but it matters.  When we are valuing companies we must take these sorts of things into account so that we can fully understand what the true value of the company is.

It’s worth noting that companies can already claim up to £1m under Full Expensing and 99.9% of companies do not reach this threshold, so the changes to full expensing will probably only impact the UK’s very largest companies.  But however large or small the company is, Full Expensing does matter.  In particular it is probably relevant for private equity or VC backed companies investing heavily in kit to underpin their growth strategy.