The economic situation facing the country means that now more than ever, cashflow is vitally important to every business. Ensuring that business expenditure is incurred at the right time is critical to make sure that reliefs are maximised as early as possible, and if this can mean reducing tax liabilities, the cashflow of the business will be improved.
Since January 2019, the Annual Investment Allowance (AIA) limit has been £1million per year, providing 100% tax relief in the year of purchase for capital expenditure on plant and machinery and integral features.
Plant and machinery includes:
- items that are kept for use in the business
- parts of a building considered integral, known as ‘integral features’ (see below)
- some fixtures, for example fitted kitchens or bathroom suites
- alterations to a building to install other plant and machinery – this does not include repairs, which can be claimed as business expense if you are a sole trader or partner, or deducted from your profits as a business cost if you are a limited company
Integral features are:
- electrical systems, including lighting systems
- lifts, escalators and moving walkways
- space and water heating systems
- air-conditioning and air cooling systems
- hot and cold water systems (but not toilet and kitchen facilities)
- external solar shading
This means that for the large majority of businesses, full tax relief has been able to be obtained on new machinery as well as heating and electrical systems added into buildings in the year of purchase.
However, from 1 January 2021, (and not withstanding what might come out of the autumn 2020 budget) the AIA limit is due to fall to £200,000, cutting the current rate by 80%. This means that many businesses may not benefit from full immediate tax relief on all new capital expenditure in the current accounting year. Instead, expenditure will have to be written down at either 18% or 8% per year and the tax relief spread over a long period of time. This change could result in lower capital allowances claims and therefore higher profits and tax liabilities moving forward. This is especially the case where older plant, machinery and integral features are being replaced, as the assets being sold could have little tax value and the disposal could result in a tax charge.
Where a business’ accounting period straddles the change in AIA limit, the amount of relief available is a hybrid amount based on time apportionment. For example, a business with a 31 March 2021 year end will have an AIA limit of £800,000, this being 9 months of the old £1million limit and 3 months of the new £200,000 limit. However, the availability of this limit hinges on when the capital expenditure is incurred. To benefit from the full limit, as much of the capital expenditure as possible needs to be incurred by 31 December 2020. Expenditure incurred after 1 January 2020 will only benefit from the proportion of reduced allowance available in that period. In a 31 March 2021 year end, this is 3 months of £200,000, being just £50,000. The example below highlights this point.
A business has a 31 March 2021 year end and incurs £300,000 of capital expenditure on new plant and machinery in the year. The below example shows the capital allowances available in the year ended 31 March 2021, if the assets are purchased on 1 December 2020 compared to 1 March 2021.
|Asset purchased 1 December 2020||Asset purchased 1 March 2021|
|Writing down allowance 18%||(45,000)|
|Carried forward||–||Carried forward||205,000|
|Total Capital Allowances||£300,000||Total Capital Allowances||£95,000|
As you can see, just a few weeks difference in the timing of the purchase can have a drastic difference in the upfront tax relief available. If the example above applied to a business where the owners were higher rate taxpayers, the tax saving achieved by bringing forward expenditure would be £82,000. This cash flow benefit could be critical to the business.
Capital Allowance computations need careful consideration and each business’ individual circumstances are different. It is therefore advisable to discuss any significant capital expenditure with your accountant prior to making any purchase.