Capital Allowances – A Complication

Hi – I’m Paul Soper and this is the first of another series of Podcasts focussing on recent developments in Direct Taxation in the UK intended primarily for practitioners – especially small practitioners.  But if you are a reasonably financially literate taxpayer you might enjoy it too – if enjoy is the right word!  In the past these podcasts have been prepared on a sporadic basis but they will now become monthly – so this is the September 2011 edition.

Significant changes are being made to the Capital Allowances system from April 2012 onwards, this podcast looks at a particular problem which some taxpayers might face where action may be needed now.

It is often said that capital allowances are simply the tax equivalent of accounting depreciation, depreciation being added back and capital allowances deducted in arriving at trading profit.  However you don’t need to charge depreciation to be able to claim the allowances and many assets don’t qualify for capital allowances at all, and that list became longer with the abolition of the Industrial Buildings Allowance and the Agricultural Land and Buildings Allowances from April 2011 onwards.  In truth – Capital Allowances are and always have been an incentive to invest and should be considered as such.

Until 2008 expenditure on Plant and Machinery by businesses qualified for two types of allowance for tax purposes – a first year allowance which certain businesses could claim and a writing down allowance which enabled remaining expenditure after deduction of the first year allowance to be written off over a number of years.

Before 2008 the main rate of the writing down allowance was 25% but in that year three important changes occurred.  Firstly the main rate was reduced to 20% and then a new category of writing down allowance at the rate of 10% was created for expenditure on integral assets, like lifts and escalators, central heating and air conditioning, installed in a building.  However the special rate pool as it was called also included expenditure on the thermal insulation of commercial buildings and private motor vehicles which had a stated CO2 emission in excess of 160g/km.

Businesses could also claim an annual investment allowance of up to £50,000 for expenditure on assets of either type, with the exception of cars and leased assets.  This was of enormous benefit to smaller businesses, particularly those with expenditure within this limit who could now claim the equivalent of a First Year Allowance on practically all they spent except for private motor cars and leased assets.

The system retained the First Year Allowance as well – at a rate of 100% for certain energy and resource efficient assets, which I’ll return to later.

 From April 2010 onwards the amount of the Annual Investment Allowance was doubled to £100,000 but for any business whose accounting date was not 31 March or 5 April the allowance for expenditure before those dates was limited to the allowance that would have applied on the date of the expenditure – limiting the total that could be claimed to £50,000.

When they came to power the coalition government announced that these rates would change from April 2012 onwards, the writing down allowance of 20% being reduced to 18%, the special rate pool allowance of 10% being reduced to 8% and the annual investment allowance being reduced to £25,000.  These changes were given legal effect in Finance Act 2011 but one change has a rather nasty side effect which we have to watch carefully.

If the accounting date of a company is 31 March one merely needs to apply the correct rates to the accounting period in question, the same being true for an individual sole trader or partnership with an accounting year end of 5 April, or by concession 31 March where they can pretend that the accounting date is 5 April.

But if anyone uses an accounting date other than these there is a problem, lets look at an example.

Consider a company called Gideon Ltd which prepares accounts each year to 31 December.  On 14th April 2012 it spends £40,000 on several new machines.  For the year to 31 December 2012 it will be necessary to calculate the appropriate hybrid writing down allowance as for the first three months of the year the rates were higher than for the remainder of the year.  This calculation must be done on a daily basis and there are 366 days in this accounting year because of the leap year.

The appropriate fraction is 91/366ths for the allowances of 20% and 10%, and is 275/366ths for the later lower allowances of 18% and 8% giving hybrid allowances of 18.5% and 8.5% respectively.

Had this been a sole trader or partnership of individuals, where the change in the rate occurs on the 6th of April, the fractions would be 96/366ths and 270/366ths giving rates of 18.52% and 8.52% respectively.  Allowances are always rounded up where necessary to two decimal places.

However the catch comes when we look at the annual investment allowance.  This was introduced in 2008 at the level of £50,000 and then doubled to £100,000 in April 2010, just before the general election.  Now it is being reduced to £25,000 from April 2012, again requiring a hybrid calculation, but this time we can choose between using a daily basis or a monthly basis – as long as our use is consistent.

So the company will be entitled to claim either 3/12ths of £100,000 plus 9/12ths of £25,000 – that’s £43,648 or on a daily basis 91/366ths of £100,000 plus 275/366ths of £25,000 – which is £43,750  – the monthly basis seems best although only by £102.

 But Gideon Ltd cannot claim the whole amount because the expenditure was incurred after the 31st of March.  The Finance Act 2011 specifies a different limit for expenditure after 31st March, or for an individual 5th April to the limit that was applied when the allowance was doubled in 2010.  This new method requires the taxpayer to treat the period after 31st March or 5th April as though it were a completely separate accounting period, in this case one which is 275 days or 9 months long.  9/12ths of £25,000 is £18,750, whereas 275/366ths is £18,785.  This means that if there is no other expenditure the daily basis should be used giving a maximum allowance which is £35 higher.

If we were looking at a taxpaying individual the fractions would be 3/12ths plus 9/12ths giving a total, as before of £43,750 or 96/366ths plus 270/366ths giving a total of £44,673 for the whole year. The daily basis seems to give a total allowance which is £922 more, but on a daily basis the amount that relates to the period from 1 April onwards is only £18,442 rather than the £18,750 available on a monthly basis, £308 less.

Of course this means that there is no hard and fast rule of thumb, in each case the calculations should be made on either a monthly or a daily basis, but you cannot pick and choose.

It also means that if you had an accounting period ending earlier in the year the limit of relief available on expenditure incurred after 31st March or 5th April would diminish – with a 30th April year end the limit on expenditure incurred after those dates would be a maximum of £2,083.

Clearly the amount of the Annual Investment Allowance available will be affected by the accounting year but also by the date on which the expenditure was incurred so this begs the question – can you change the date by reference to which the capital allowance is given?  If we look at the legislation contained in the Capital Allowances Act of 2001 we discover that the date on which capital allowances are given is not, as is commonly thought, the date on which the contract is entered into.  Nor is it the invoice date, the date on which the asset was brought into use or the date of payment, well – normally.

 It is the date on which you become legally obliged to make a payment and with the co-operation of the vendor of the machinery it may be possible to specify a date before 1st April which would allow Gideon Ltd to claim the whole £40,000.  This would apply even if Gideon Ltd still made the payment on the same date as before.  There is an anti-avoidance provision so that if payment is made more than 4 months after the obligation date the allowance is then determined by the date of payment.

 Another possibility would be to change the company’s accounting date so that it ended on 31st March – this would leave the expenditure in a later period that did not straddle 31st March and a whole £25,000 could be claimed, albeit a year later.

 So – action is needed now by any business planning to spend substantial sums on plant and machinery.  Even if you have a 31st March or 5th April year end, so the catch doesn’t apply, accelerating relief into the year to 31st March or 5th April 2012 could give you up to four times the relief that expenditure after that date will bring.

 There is one more important consideration for Gideon Ltd – is it possible that the new machinery qualifies as energy efficient by the criteria laid down by the Department of Energy and Climate Change?  This can be checked at http://www.eca.gov.uk.  If it is then quite separately from the Annual Investment Allowance system a 100% First Year Allowance will be available for the qualifying expenditure.

It is worth noting that this also applies to water efficient technologies and to cars with a CO2 emission of 110g/km or less.  However the relief for cars will come to an end, at present, from April 2013 onwards.  Do not be misled here by the website which suggests initially that the 100% allowance for certain cars ended on 31 March 2008.  The website has not been properly updated – follow the car link through to the HMRC website and you will eventually uncover the right information which is available in the revenue’s capital allowance manual at page CA23153.

This podcast taxt was presented, written and produced by Paul Soper who asserts copyright therein.  The older podcasts can be accessed from http://web.me.com/paulsoper and the new series of which this is the first from http://web.me.com/paulsoper/paulsoper as well as from Apple’s iTunes store where they are available to download for free.

For further details of podcast production, particularly if you would like me to create them for you, contact me at Paulsoper@mac.com.