The cost of acquiring plant and machinery for ongoing use in a business is a significant outlay for any enterprise. Items which are of enduring benefit to a business (typically anything expected to last more than two years) are not fully deductible in their year of acquisition for the purposes of calculating the liability to tax on profits.
Items which are of enduring benefit to a business (typically anything expected to last more than two years) are not fully deductible in their year of acquisition for the purposes of calculating the liability to tax on profits. Instead, relief takes the form of allowances which may be claimed for capital expenditure on certain assets used in carrying on a business, typically spending on plant and machinery but also research and development and patents. These ‘capital allowances’, often referred to as the tax equivalent of depreciation, allow relief against tax for the cost of the asset over the asset’s useful working life.
Unlike depreciation, it can take many years before tax relief on the full cost of the asset is obtained. This is because for plant and machinery, the allowance can be claimed annually at 18%, dropping to 8% if asset is an integral feature (eg a lift). To use an example:
- expenditure of £1 million would receive an allowance of £180,000 in the first year;
- the asset would then have a value, for capital allowances, of £820,000;
- the following year, the allowance would be £147,600 (being 18% of £820,000), and so on.
Enter the AIA. It provides a 100% allowance on qualifying expenditure up to a prescribed amount each year. Recently the amount has varied from its current high of £500,000 down to a low of £25,000, to which it was due to return. The Summer Budget, however, announced that from 1 January 2016 the AIA would settle at £200,000 for the foreseeable future.
As with comedy, however, timing is everything. Capital allowances are available by reference to the fiscal year. For companies whose accounting period straddles 1 January 2016, they will need to adjust the value of the AIA which they can claim in that period. This can have surprising consequences. For example:
- a company’s accounting period is from 1 April 2015;
- the level of AIA is £500,000 per year as at 1 April 2015, falling to £200,000 per year on 1 January 2016;
- • accordingly, the company is entitled to an AIA of only £425,000 (being 9/12 x £500,000, and 3/12 x £200,000);
- meaning that an expenditure of £500,000 incurred on 1 April 2015 will no longer be relieved in full in the year of acquisition, contrary to what was expected at the time of purchase.
An additional restriction operates to restrict the level of AIA available for expenditure incurred on or after 1 January 2016. The level of the AIA is calculated by looking at the period after 1 January 2016 as if it were a period on its own. To continue the example above:
- the company’s accounting period ends on 31 March 2016;
- over the 12 month period, the level of AIA is £425,000;
- however the AIA available for expenditure incurred on or after 1 January 2016 is only £50,000, being 3/12 x £200,000;
- even if no expenditure had been incurred prior to 1 January 2016, the £50,000 cap remains.
For one final, extreme, illustration of the benefits of proper preparation, let’s continue the example. Take three companies, each:
- having an accounting period from 1 April 2015 to 31 March 2016;
- having an AIA for that year of £425,00; and
- spending £425,000 in that year:
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This stark example shows the importance of considering when to incur expenditure, as well as how much to incur. If Company B could incur its expenditure before 1 January, or could change its accounting period so that it started on 1 January, a greater proportion of the same expenditure would qualify for 100% AIA.