The general rule is that a capital expenditure is not allowed in the computation of profits but instead capital allowances may be claimed.
The types of these allowances are:
1. Annual investment allowance (AIA).
2. First year allowance (FYA).
3. Writing down allowance (WDA).
4. Balancing allowance (or balancing charge).
5. Allowances for cars and vans.
A 100% annual investment allowance (AIA) can be claimed for the first ₤500,000 of expenditure on plant and machinery (excluding cars). In addition to a claim for AIA, a writing down allowance can be claimed. The rate currently is 18% but for certain special rate expenditure the rate is 8%.
A first year allowance (FYA) of up to 100% is available on certain expenditure.
For the first year a tax credit is available to a company that has incurred a loss on account of enhanced allowances for “green” plant and machinery. Such a loss can be exchanged for cash instead of carrying forward to set against future profits.
The capital allowances available currently are for expenditure with regard to:
1. plant and machinery;
4. research and development; and
5. mineral extraction.
The capital allowances for the above are available to sole traders and partnerships in respect of cash businesses. With regard to companies, however, CAs are no longer available on expenditure for patents and know-how with effect from 1 April 2002.
In this regard, relief is given by a deduction in calculating income under what is known as the “intangible assets” rules. Relief can be claimed for first-year tax credit equal to 19% of the loss, subject to certain restrictions, and there is an upper limit.
Expenditure Qualifying for Capital Allowances Relief
The law under which the relief is claimed is basically under legislation passed from time to time.
Capital allowances are available for expenditure on qualifying assets, regardless of how the purchase was financed. This includes capital allowances for property.
Interest payable on a loan to purchase an asset is generally allowed, but not as part of the cost of the asset.
Such a qualifying loan interest, among a number of reliefs against income, is subject to a restriction from 2013-14.
Scheme Designed to Enhance CAs. Such a scheme is likely to fail. In The Brain Disorders Research Limited Partnership v HMRC, the FTT found that schemes designed to enhance capital allowances and interest relief failed to work.
By using hypothetical simple numbers the schemes used broadly worked by the partnership paying ₤100 to a special purpose vehicle (SPV) for the undertaking of research work. The sum paid was verified by a third party.
The SPV then subcontracted the work.
Overview of Capital Allowances UK
1. A capital allowance (CA) is essentially a way of accounting for depreciation for tax purposes. It is a system of writing off the cost of an asset over a period of years, the time taken to write down the asset and the rate at which the asset depreciates depend on the nature of the asset involved.
2. CA is a tax allowance a taxpayer can claim on the purchase of “plant and machinery”, or equipment which is used in a business. CA can also be claimed, for example, on the cost of converting space above shops or other commercial premises for renting out as flats.
3. CA can also be claimed on computer hardware and software, scanners, phones and faxes, etc.
4. There is no single definition of what qualifies as plant and machinery although it does include items such as expenditure on fire safety or safety at sports grounds.
5. A claim cannot be made for any asset bought for one’s private use but if the use is partly private and partly for business a claim can be made for CAs in respect of the business part.
6. CAs are deducted from profits to arrive at the taxable amount.
7. Even if an asset is bought on hire purchase, a claim can still be made for CAs, but any interest should be taken off profits as a business expense.
8. The deduction of CAs is from profits to arrive at a reduced taxable amount.
Adjustment of Profits Before Deduction of Capital Allowance UK Reliefs
All trading profits are to be collated and adjusted to arrive at the taxable profits, which are the residue after deducting allowable expenses from trading receipts.
To calculate the taxable profits it is necessary to determine which accounting period forms the basis of the assessment for the tax year and to identify the taxable income and allowable expenditure relevant to the basis period.
Thereafter, CAs and losses for any previous year should be deducted.
Capital Allowances Available
Tax allowances called “capital allowances” can be claimed for some types of capital expenditure.
Like other expenses, these are deducted in working out taxable profits, such as from rental business profits or added to any loss. Significant changes have been made to capital allowances in recent years. The basis period for computing capital allowances is generally the tax year.
Grants towards capital expenditure are normally deducted in arriving at the amount on which capital allowances are due.
The cost incurred in acquiring fixed assets is a capital expenditure and, therefore, not deductible from income earned. However, CAs are allowed in respect of certain but not necessarily all capital assets.
Once eligible, the allowances can be deducted each year based on a percentage of the value of the asset or pool of assets. The allowances are given on a reducing balance basis known as writing down allowances (WDA).
To be eligible for WDA the capital assets must fall into any of the following categories:
(a) plant and machinery;
(b) integral features;
(c) industrial buildings (phased out from 2011-12);
(d) patents; and
(e) agricultural buildings and works (phased out from 2011-12).
Those listed under (a) and (b) are the most common and so were those under (c) in the past.
Instead of depreciation of business assets, various “capital allowances” are allowable as deductions from assessed profits. CAs represent what amount of the fixed capital can be written-off (deducted from profits) each year for tax purposes.
In the first few years the written-off amount is greater than the previous depreciation amount which it has replaced. This means that the tax relief is skewed towards the front end of the life of an asset, resulting in lower tax in the earlier years.
Those listed under (a) and (b) are the most common. Also, (c) was common in the past.
The Finance Act 2008 Reforms Regarding Capital Allowances
The changes on CAs introduced in the FA 2008 are the biggest reform of the capital allowances system since the 1980s.
The changes were part of a wider “Business Tax Reform” package, which included a 2% cut in the main rate of corporation tax. The reforms had three main objectives:
1. To promote investment and growth.
2. To reduce distortions and complexity.
3. To maintain fairness and refocus the tax system for smaller businesses.
The main changes for capital allowances were:
(a) the introduction of a new annual investment allowance (AIA), which was effectively a 100% allowance for business expenditure on plant and machinery (apart from cars) up to £50,000 a year.
The AIA applies to businesses regardless of size, and replaced the previous 40% or 50% for small and medium-sized businesses only;
(b) a new small pools allowance, allowing historic and future pools of plant and machinery expenditure of £1,000 or less to be written-off immediately;
(c) new payable tax credits for businesses that make losses attributable to investment in environmentally beneficial plant and machinery;
(d) the phased withdrawal of industrial and agricultural buildings allowances by 2011;
(e) changes to the rates of CAs on plant & machinery from 25% to 20% for the main pool, and from 6% to 10% for long-life assets in the new special rate pool; and
(f) the introduction of a new classification of “integral features” of a building or structure to apply to new and replacement expenditure and which will attract allowances in the special rate.