Now more than ever, cashflow is vitally important to businesses. As tax rules change, ensuring that expenditure is incurred at the right time is critical to make sure that reliefs are maximised as early as possible, reducing tax liabilities and aiding with cashflow.
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. This means that for the large majority of agricultural businesses, full tax relief has been able to be claimed on new farm machinery as well as heating and electrical systems added into stores and buildings in the year of purchase.
However, from 1 January 2021, the AIA limit is due to fall to £200,000, cutting the current rate by 80% and meaning many businesses in the agricultural sector may not benefit from full immediate tax relief on all new capital expenditure in the current accounting year. Instead, expenditure will be written down at either 18% or 8% per year and the tax relief will be 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 machinery is 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 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 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.
As you can see above, just a few weeks difference in the timing of the purchase can have a drastic difference in the up front 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.