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Capital Allowances:
Business Cars & Vehicles

New rules may significantly affect your tax bill

The new capital allowances regime for cars used in business comes into force on 1st April for companies and 6th April for other businesses. Deciding whether to replace your car before the change takes effect is critical and could alter your tax bills by thousands of pounds over the next few years.

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Company Owners or Sole Traders

The Current Position
At present, cars costing more than £12,000 must be ‘de-pooled’ and kept as a single, separate, asset for capital allowances. The writing down allowance on the car is given at the same 20% rate as for other business assets, but is limited to a maximum of £3,000 each year.

Cars which are also used privately by sole traders or business partners must be ‘de-pooled’ regardless of cost. These are again subject to the £3,000 limit, with a further reduction in the allowance to reflect the element of private use.

Other cars costing £12,000 or less are added to the ‘general pool’, along with all of the business’s other capital equipment, and attract writing down allowances at 20%.

Where cars are ‘de-pooled’, this carries one major advantage. When the car is sold, full allowance is given for any remaining depreciation. Let me explain this with a short example.

Pertwee Limited buys a new car for the company’s managing director on 1st March 2009 at a cost of £40,000. The company has a 31st December accounting date. For each of the years ended 31st December 2009, 2010 and 2011, the company claims a capital allowance of £3,000 on the car, leaving an unrelieved balance of £31,000.

In 2012, the company sells the car for £12,000. As the car is ‘de-pooled’ under the existing regime, the company is entitled to a balancing allowance of £19,000 (£31,000 - £12,000) which will be deducted from its taxable profits.

Under current proposals, cars purchased before the change takes effect will continue to be subject to the existing regime for a further five years.

This means that balancing allowances like the one in the example will continue to be available provided that the new car is purchased before the change and sold within five years.

The New Regime
Under the new regime, only cars used privately by sole traders and business partners will continue to be ‘de-pooled’. ‘De-pooling’ will cease for all other cars purchased after the change. For ease, I will refer to all these other cars as ‘company cars’, but please remember that this includes any cars provided to employees by sole traders or partnerships.

Company cars with carbon dioxide (CO2) emissions of over 110g/km but no more than 160g/km will be added to the general pool and attract writing down allowances at 20%. Cars with higher CO2 emissions will be added to a ‘special rate pool’ and attract writing down allowances at just 10%.

The £3,000 limit on allowances will no longer apply, which will be good news for some, but, most importantly, there will be no balancing allowance when the car is sold. Instead, the sale proceeds will simply be deducted from the balance on the pool.

Let us now suppose that Pertwee Limited buys the managing director’s new car on 1st April 2009. The car now falls under the new regime; as it has CO2 emissions of 170g/km, it falls into the ‘special rate pool’. The new car therefore attracts allowances of £4,000 in 2009, £3,600 in 2010 and £3,240 in 2011, leaving an unrelieved balance of £29,160.

So far, the company has benefited from the new regime, as the allowances have not been restricted to £3,000 per year. However, when the car is sold in 2012, the company does not get a balancing allowance but is merely entitled to a 10% writing down allowance on the balance left after deducting the sale proceeds. Ignoring the impact of any replacement car, this will amount to just £1,716 (£29,160 - £12,000 = £17,160 x 10%), leaving an unrelieved balance of £15,444.

Looked at another way, the current regime ensures full relief for the economic cost of a car (i.e. purchase price less disposal proceeds) over the life of that car, even if a large part of that relief only arises on disposal. Under the new regime, our example shows less than half of the economic cost of the car being relieved over its life. The remaining balance in this case will continue to attract writing down allowances at just 10%. This operates on a reducing balance basis, meaning that even ten years later, more than a third of this balance will still be unrelieved!

In most cases, therefore, it will be advantageous to replace company cars with high CO2 emissions before the change takes effect in April.

Cars with Lower C02 Emissions
Pertwee Limited also buys a car for its sales director on 1st April 2009, again at a cost of £40,000. This car has CO2 emissions of 155g/km and therefore falls into the general pool where it attracts writing down allowances at 20%. The allowances thus amount to £8,000 in 2009, £6,400 in 2010 and £5,120 in 2011. The total allowances so far amount to £19,520, which is more than double the £9,000 which the company would have been able to claim if it had bought the car a day earlier.

After selling the car for £12,000, there is an unrelieved balance of £8,480 (£40,000 - £19,520 - £12,000) which again attracts a further 20% writing down allowance, leaving just £6,784 carried forward.

As we can see, for expensive company cars with moderate CO2 emissions, there is initially a cashflow advantage in replacing the car after the change takes effect. Ultimately, however, a large part of the car’s economic cost remains unrelieved after sale (almost a quarter in this case). This unrelieved balance is written off at the faster rate of 20% but, again, on a reducing balance basis which, this time, leaves almost a third still unrelieved five years later.

For less expensive cars, the initial cashflow advantage is less pronounced. In fact, it disappears after four years for cars costing less than £29,300, after three for cars costing less than £23,440 and never exists at all for cars costing £15,000 or less.

It will therefore generally make sense to buy any company cars costing between £12,001 and £23,440 before the change takes effect. (Cars costing £12,000 or less already fall into the general pool, so the change makes no difference unless the car has CO2 emissions over 160g/km.)

Expensive Cars
For more expensive cars, the decision is less clear-cut due to the initial cashflow advantage (except where CO2 emissions exceed 160g/km) and will depend on the cost of the car, its expected useful life and its anticipated sales value.

Note that, in the rare instance that a car is sold for more than its unrelieved balance under the current regime, a balancing charge arises for the difference. This will not arise under the new regime for company cars, so it may be wise to delay the purchase of any cars which are likely to depreciate more slowly than the current rate of tax relief.

Cars bought by sole traders and business partners for their own use
These cars continue to be ‘de-pooled’ under the new regime, provided there is some element of private use (the reduction in allowances to reflect private use continues). Under current proposals, the £3,000 limit on allowances will again cease to apply but cars with CO2 emissions in excess of 160g/km will attract a writing down allowance of just 10%.

In many cases, it will therefore make sense to delay the purchase of these cars until after the new regime comes into force on 6th April since the abolition of the £3,000 limit will create the same cashflow advantage as we have seen for company cars, without the loss of the balancing allowance.

The main exception to this applies to cars costing less than £30,000 with CO2 emissions of more than 160g/km.

If the car has no private use, it will be treated like a company car. My advice: take it to the shops once a year, claim 99% business use and get your balancing allowance when you sell it!