Big Changes Ahead
Planned Reductions to Capital Allowances
IN DECEMBER, the Government announced further details of its planned reductions in the amount of capital allowances available to all UK businesses. The reductions will have a severe impact on any businesses investing significant amounts in machinery, equipment, commercial vehicles, commercial property or furnished holiday lets.
The changes planned for 2012 may seem a long way off but transitional rules mean that, for many businesses, the reduction in allowances will start to bite much sooner: as early as May 2011 in some cases!
The Current Rules
Under the current rules, most businesses are entitled to an annual investment allowance of up to £100,000 per year. This means that the business obtains immediate 100% relief for up to £100,000 a year of qualifying expenditure on items like machinery, office equipment, furniture and vans.
A large part of any expenditure on commercial property or furnished holiday lets also qualifies because ‘integral features’ are also eligible for the annual investment allowance. ‘Integral features’ include heating, air-conditioning, electrical and lighting systems, hot and cold water plumbing, lifts and escalators, so they make up a large part of the cost of any qualifying building.
Most businesses are therefore currently able to benefit very significantly from the annual investment allowance, with one major exception: sadly, apart from furnished holiday lets, expenditure on, or within, residential rental property does not generally qualify for capital allowances.
Qualifying expenditure in excess of the annual investment allowance is currently eligible for a writing down allowance of 20%, or 10% in the case of integral features which, along with any items with a useful working life of 25 years or more, are allocated to the ‘special rate pool’. Cars, which are ineligible for the annual investment allowance, also attract writing down allowances of either 10% or 20%, depending on the level of the car’s CO2 emissions.
Example Part 1
Woody runs a toy manufacturing business and draws up accounts to 30th April each year. In April 2011, he buys a new workshop and spends a total of £60,000 on integral features within the property. He also buys new equipment for the business at a total cost of £50,000.
Woody is allowed to claim his annual investment allowance on his integral features first. He does this because they would otherwise only get a writing down allowance of 10%. This leaves a further £40,000 of annual investment allowance available for Woody to claim on his new equipment. The last £10,000 of Woody’s expenditure attracts a writing down allowance of 20%, i.e. £2,000.
Hence, in total, Woody is able to claim capital allowances of £102,000 for the year ending 30th April 2011. The remaining £8,000 of his qualifying expenditure is carried forward in his ‘general pool’ and will continue to attract writing down allowances in future years.
Changes to Come
Under current Government proposals, the rates of capital allowances will be drastically reduced from April 2012, as follows:
- The maximum annual investment allowance will be reduced from £100,000 to £25,000
- The rate of writing down allowances on the general pool will be reduced from 20% to 18%
- The rate of writing down allowances on the special rate pool will be reduced from 10% to 8%
These changes will take effect from 1st April 2012 for companies and from 6th April 2012 for other businesses. To illustrate their impact, let’s look at what they would do to Woody.
Example Part 2
In April 2013, Woody buys another new workshop which again includes a total of £60,000 worth of integral features and he also spends another £50,000 on new equipment.
This time, he can only claim an annual investment allowance of £25,000 on his integral features, leaving £35,000 to fall into the special rate pool where it attracts a writing down allowance of just 8%, or £2,800.
As his annual investment allowance has now been exhausted, all of Woody’s expenditure on new equipment falls into the general pool and attracts a writing down allowance of just 18%, or £9,000.
This time, Woody’s capital allowances total just £36,800 (£25,000 + £2,800 + £9,000), compared with £102,000 for exactly the same expenditure two years earlier!
If Woody were a sole trader with taxable profits, before capital allowances, of over £252,000, this reduction in his capital allowances would cost him an extra £33,904 in additional Income Tax (at 50%) and National Insurance (at 2%). That’s over half the cost of the integral features in another workshop: not exactly encouraging investment are we Mr Osborne?
So far, we’ve seen how generous the current capital allowances rules are and how drastically they will be cut back after April 2012. We now need to consider what will happen in the meantime, where a business has an accounting period straddling the date of the changes in April 2012. Some businesses, like Woody’s, will be starting these accounting periods as early as 1st May 2011.
For the most part, the transitional rules operate by a system of simple ‘time-apportionment’. In other words, the old rates are applied to the part of the accounting period falling before the date of change and the new rates are applied to the part of the accounting period falling on or after the date of change.
For example, a company with a twelve month accounting period ending 31st December 2012 will be able to claim a maximum annual investment allowance for that year of:
£100,000 x 91/366 = £24,863
£25,000 x 275/366 = £18,784
Similar principles apply to give the same company a rate of 18.5% for the writing down allowances on its general pool that year and 8.5% on its special rate pool. These transitional rates apply to expenditure incurred at any time in the accounting period, as well as balances brought forward from the previous period.
The maximum annual investment allowance derived under the transitional rules also applies to the total expenditure in the accounting period but an additional rule applies to restrict the amount of expenditure incurred after the date of the change which may qualify.
For expenditure incurred in the part of the accounting period falling on or after the date of change, the maximum annual investment allowance is calculated as if this were a separate accounting period.
Hence, for example, a company with a twelve month accounting period ending 31st December 2012 can claim an annual investment allowance of up to £43,647, but no more than £18,784 of the qualifying expenditure can take place after 31st March 2012.
For someone like Woody, who seems to be in the habit of making most of their capital expenditure towards the end of their accounting period, this could be absolutely disastrous!
Example Part 3
Woody is a sole trader and is drawing up accounts for the twelve month accounting period ending 30th April 2012. His maximum annual investment allowance for the whole of this period is:
£100,000 x 341/366 = £93,169
£25,000 x 25/366 = £1,708
Overall, this is not too bad, but what Woody must remember is that the allowance available for expenditure between 6th and 30th April 2012 is just £1,708.
Hence, if Woody spends his usual £60,000 on integral features and £50,000 on other equipment before 6th April 2012, he will be able to claim an annual investment allowance of £94,877 and a writing down allowance of 19.87% on the remaining £15,123 of his expenditure, giving him total allowances of £97,882.
If Woody incurs this expenditure between 6th and 30th April 2012, however, he will be able to claim an annual investment allowance of just £1,708, together with writing down allowances of 9.87% on the remaining £58,292 of his integral features and 19.87% on his other equipment purchases, giving him total allowances of just £17,396.
The Government claims that it wishes to make the UK tax system both simpler and fairer and yet a difference of just one day in the timing of his expenditure could cost Woody over £80,000 in lost capital allowances!
In summarising the impact of these changes, it all comes down to two key dates:
i) The date of the change: 1st April 2012 (for companies), or 6th April 2012 (for other businesses)
ii) The date on which your last accounting period ending before the date under (i) ends
For some businesses these are effectively the same date (or two consecutive dates to be precise). These businesses will not be affected by the transitional rules and will move straight from the current capital allowances rates in one period to the new rates in the next.
Those who are affected by the transitional rules, however, need to take extra care!
In terms of how to plan for the changes, it all depends on how much qualifying expenditure you expect to incur.
If you never expect to spend more than £25,000 a year then the only thing you need to be wary of is the restriction which applies to any expenditure incurred between the date of the change and the end of your accounting period which straddles that date. For example, remember that poor Woody was entitled to an annual investment allowance of just £1,708 on expenditure during this period. You should therefore generally try to maximise your expenditure before the date of the change or else defer it until your next accounting period.
If you regularly spend more than £100,000 every year, then you will benefit from the maximum annual investment allowance available for each period. You will, however, again need to be wary of the period falling between the date of the change and the end of your accounting period which straddles that date. You may wish to accelerate expenditure planned for the latter part of that accounting period so that it falls before the date of the change.
Those businesses whose qualifying expenditure fluctuates and sometimes falls between £25,000 and £100,000 in a year will benefit the most from carefully planning the timing of their expenditure. Both of the key dates set out above will be critical to that planning.
For these businesses to achieve the maximum benefit will require a detailed review but, in general terms, it will usually be beneficial to:
- Maximise the expenditure falling before each of the key dates at (i) and (ii) above
- Restrict any expenditure falling between the date of the change and the end of the accounting period straddling that date to no more than the maximum annual investment allowance available for that part of the accounting period
- Defer any further expenditure until the next accounting period
For example, a company with a 31st December year end would obtain the maximum benefit by spending £100,000 in the year ending 31st December 2011 and £43,647 in the year ending 31st December 2012, of which at least £24,863 needs to be incurred by 31st March 2012.
Naturally, all of this is subject to the commercial requirements of the business. It is seldom worth spending money just to save tax. It is, however, often worth spending money either a little sooner or a little later!
Where assets are bought on hire purchase, the effective date of expenditure for capital allowances purposes will be the later of the date of purchase and the date the asset is brought into use in the business.