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April 2008, the 2008/09 tax year, sees a major reform to Capital Allowances.

What are Capital Allowances?

Business expenditure is split into two types:

– Revenue expenses, essentially “running costs” for your business, eg rent, wages, electric bills, stationary, advertising

– Capital expenditure – expenditure on long term assets, tangible assets such as equipment, vehicles and premises, or intangibles such as goodwill.

Revenue expenditure is, generally, allowable in full as an deduction against your income in the year the expenditure is incurred. There are numerous twists to this, of course, which are too complicated to go into here.

Capital expenditure is, generally, not allowable as a tax deduction in full. Different rules apply for different types of assets:

– intangibles, eg goodwill. For companies, written off against tax over its useful life. For sole traders and partnerships, no relief.

– equipment & vehicles – capital allowances are given in the form of first year allowances and writing down allowances, to attempt to match tax relief over the life of the asset

– premises – some business qualify for Capital Allowances known as Industrial Buildings Allowances and / or Agricultural Buildings Allowances.

Whats changing?

Two main changes:

– a phasing out of Industrial Buildings Allowances and Agricultural Buildings Allowances

– a major reform of capital allowances on equipment

Industrial Buildings Allowances and Agricultural Buildings Allowances

The number of businesses who qualify for these is quite few – shops, offices, workshops and, in most cases, warehouses / stores do not qualify.

However factories and some hotels qualify of IBAs and many farm buildings qualify for ABAs.

IBAs and ABAs are currently given at 4% per annum on qualifying expenditure.

This 4% will be reduced in 1% steps from the 2008/09 tax year so that from 2011/2012 its 0% and the allowances have been abolished.

For those who have claimed IBAs / ABAs there is no immediate clawback, but the existing arrangements for clawback on sale will still apply.

Equipment – current rules

At present most equipment has a initial first year allowance of 50%, and thereafter a writing down allowance of 25% per annum the reducing balance. Vans and motorcycles are treated as any other equipment. Cars have two special rules (i) no first year allowance and (ii) allowances restricted to £3,000 per vehicle PA.

For example supposing £20,000 is spent on (i) equipment (including vans / motor cycles) and (ii) a car. Relief against tax is given as follows:

Tax Year Equipment £ Car £
Spent 20,000 20,000
Tax year 1 Allowance 10,000 3,000
carried forward pool 10,000 17,000
Tax year 2 Allowance 2,500 3,000
carried forward pool 7,500 14,000
Tax year 3 Allowance 1,875 3,000
carried forward pool 5,625 11,000
Tax year 4 Allowance 1,406 2,750
carried forward pool 4,219 8.250
Tax year 5 Allowance 1,055 2,063
carried forward pool 3,164 6,188
Tax year 6 Allowance 791 1,547
carried forward pool 2,373 4,641

These are the amounts allowed against tax as an expense. The tax saved will, of course, be a percentage of this. EG £10,000 allowance in tax year 1 will equate to £2,000 off the Tax bill of a company paying 20% Corporation Tax.

Apart from cars costing over £12,000 most other assets are “pooled” and allowances given on the pool of expenditure. Cars costing over £12,00 have an individual pool.

When an pooled asset is sold the monies are deducted from the pool, and if the residual amount is negative there is a balancing charge (effectively negative capital allowances) made.

If a expensive car (over £12,000 original cost) is sold, then the difference between the pool and the sale proceeds is given as extra allowances (balancing allowance) or negative allowances (balancing charge) in the year of sale.

Equipment – new rules

From the 2008/09 tax year, businesses will have a “Annual Investment Allowance”, AIA.

This is set at £50,000 and all qualifying expenditure up to the AIA in any one year will be given as a deduction in full.

Qualifying expenditure for the AIA will be broadly:

– All equipment expenditure other than cars

– Certain “Integral features” to buildings, eg non trade specific, heating and lighting systems (trade specific systems generally qualify as equipment).

Any expenditure in excess of the AIA in one year will be pooled and relieved at 20% per annum reducing balance in most cases (for some so called “long life” assets (life expectancy over 25 years), 10%).

The rules for vehicles, at present, remain unchanged, but there has been talk of a new system of allowances linked to CO2 emissions.

EG, suppose a business spends either (i) £20,000 or (ii) £200,000 in any one year on equipment – heres how the relief would work:

Tax year Equipment £ Equipment £
Spent 20,000 200,000
Tax year 1 Allowance 20,000 50,000
carried forward pool 150,000
Tax year 2 Allowance 30,000
carried forward pool 120,000
Tax year 3 Allowance 24,000
carried forward pool 96,000
Tax year 4 Allowance 19,200
carried forward pool 76,800
Tax year 5 Allowance 15,360
carried forward pool 61,440
Tax year 6 Allowance 12,288
carried forward pool 49,152

 

Again, the allowance is the deduction against tax – the actual cash saved depends on the tax rate.

These changes apply to companies, sole traders and partnerships.

Restrictions apply to split the allowance between related businesses, and to increase or reduce the AIA for allowances of more than, or less than, 12 months.

Other Capital Allowances

Other capital allowances, eg:

– Intangible Assets

– Flat conversions over shops

– Business premises renovation in disadvantaged area

remain unchanged.

Planning Points

The big planning issues are around planned expenditure on equipment in coming months.

If you are planning to spend up to £50,000 in the next year, you are probably best deferring this till after April 2008 and therefore obtain 100% allowances rather than 50%.

If your planned spend in the next year is over £50,000 then you need to consider whether it is better to accelerate expenditure so that it is incurred before April 2008, thus achieving 50% allowance on all the expenditure rather than 100% on £50k and 20% on the remainder. This will require a cash flow analysis to see the best option, from the perspective of tax outflows.

These thoughts are shared as a thought starter, and no responsibility is accepted for them. Please take professional advice before following any particular course.

More information

There is more information on the changes at:

http://customs.hmrc.gov.uk/channelsPortalWebApp/downloadFile?contentID=HMCE_PROD1_028217

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