Capital allowances offer a valuable tax benefit to those businesses investing in capital purchases. The Annual Investment Allowance is a relatively straight forward and generous allowance that most businesses can benefit from.
Since 1 January 2019, businesses have been entitled to 100% relief for the first £1,000,000 spent on plant and machinery which qualify for capital allowances (other than cars). This was an increase of £800,000 from the previous allowance of only £200,000.
Originally the £1,000,000 allowance was only intended to be in place for one year; however, the Government extended the extra Annual Investment Allowance for another year. Despite COVID-19’s effect on the economy, the Annual Investment Allowance limit is still scheduled to revert to £200,000 from 1 January 2021. The transitional rules which cover this reduction in the Annual Investment Allowance mean that the timing of capital expenditure is crucial in order to maximise the immediate tax relief.
If your business’s year end straddles the 1 January 2021 then the transitional rules could mean your tax relief is significantly delayed if you incur expenditure on or after 1 January 2021. Below is an example of how the transitional rules work:
For a company with a year end of 31 March 2021 the Annual Investment Allowance for the period is calculated as:
1 April 2020 to 31 December 2020 – £1,000,000 x 9/12 = £750,000.
1 January 2021 to 31 March 2021 – £200,000 x 3/12 = £50,000.
This gives a total Annual Investment Allowance of £800,000.
Unfortunately, it is not simply a case of £800,000 being available for the whole period, instead the Annual Investment Allowance for the pre and post 1 January 2021 periods are capped at their own pro-rated value.
For example, if the company spent £750,000 on a production line machine in December 2020, the entire cost would be covered by the Annual Investment Allowance. The £750,000 would achieve an immediate tax saving at 19% of £142,500 in the year of acquisition.
However, if the same £750,000 expenditure was incurred on or after 1 January 2021, only £50,000 would attract the Annual Investment Allowance and the remainder of £700,000 would receive a writing down allowance at 18%, as this is a main pool item. Therefore, the company would only receive an immediate tax saving of £50,000 at 19% plus 18% of £700,000 at 19%, being £33,440. The balance of the tax relief would be received on an 18% reducing balance basis over future years.
If you are thinking of incurring significant capital expenditure in your business, we would generally recommend that you seek tax advice first, but this is currently more important than ever, given that timing is key when it comes to securing the best Annual Investment Allowance outcome.
Please contact us if you would like to discuss this further.