Businesses considering the purchase of capital equipment need to think quickly or risk missing out on significant amounts of tax relief over the next few years, the Association of Taxation Technicians (ATT) is warning.
This is due to the anticipated fall in the Annual Investment Allowance (AIA) from £1 million to £200,000 on 31 December 20201. If a business incurs significant expenditure on plant and machinery before the end of 2020, it is likely to get tax relief on the cost much earlier than if the purchase is made in the new year.
Take for example, a limited company2 with a year end of 31 March which has spent very little on plant and machinery in the difficult months since 1 April 2020 and now plans to spend (say) £500,000 on qualifying items. If they bought them by 31 December 2020, the company could get tax relief on the whole cost in one go and benefit from a £95,0003 reduction in its Corporation Tax bill on 1 January 20224.
If instead that same purchase was made in the first three months of 2021, the tax saving available on 1 January 2022 would plummet from £95,000 to just under £25,000. It would take another ten years of drip-fed relief before the company had received tax relief on 90% of its outlay5.
If, however, the company delayed that same purchase until its April 2021 – March 2022 accounting year, the resulting Corporation Tax reduction for that year would be some £48,0006. In that scenario, it would take another eight years for the company to gradually receive tax relief on 90% of its outlay.
Jeremy Coker, President of the ATT, said:
“The Annual Investment Allowance rules can catch a business unawares.
“Many businesses will have deferred decisions about purchasing capital equipment this year because of the enormous uncertainties created by the pandemic. For any which are considering such purchases now, the scheduled ending of the temporary increase in the AIA in two months’ time introduces an unwelcome additional complexity.
“With all the other pressures on the Treasury at the moment and the postponement of the Budget, the temporary increase in the AIA looks like it will come to an end as originally planned on 31 December 2020. This makes it important for businesses to plan the timing of any significant amounts of capital expenditure particularly carefully and to take appropriate professional advice.
“Although the timing of a purchase may make no difference in the long run to the amount of expenditure which qualifies for tax relief, it can make an enormous difference to how quickly that relief is received and the contribution that the relief can make to the cash flow of a business. As the recent pandemic has taught many businesses, cash is king and having to wait an additional ten years is a very long run indeed.”
Notes for editors
1. In a press release of 4 September, the ATT explained the impact for businesses if the temporary increase in AIA was not extended beyond 31 December 2020 (the date on which it will end unless there is a change in the law). The delay of the next Budget and associated Finance Bill until after that date makes it increasingly likely that the AIA limit will revert from £1,000,000 to £200,000 from 1 January 2021. As noted in this release, that drop in the limit can produce some unusual results.
2. The scheduled reduction in the AIA limit from 1 January 2021 applies equally to unincorporated businesses. As income tax rates are higher than the Corporation Tax rate, the impact of the changes on the tax liabilities of partnerships and sole traders who have high levels of qualifying capital expenditure is likely to be even more significant than the illustrations in this release.
3. In the example given, the whole of the qualifying expenditure of £500,000 would be within the increased AIA limit available up until 31 December 2020. Corporation Tax relief at 19%7 on that full amount is £95,000.
4. If the company was in the quarterly payments regime (typically a company with annual taxable profits of £1.5 million or more), it would get the benefit of the tax relief earlier in its quarterly instalments.
5. In this scenario, the AIA limit on expenditure in the three months to 31 March 2021 would be £50,000. The remaining £450,000 of expenditure would qualify for a writing down allowance (WDA) of 18% (on a reducing balance basis) giving an allowance for the year of £81,000. Corporation Tax relief at 19%6 on the combined allowance for the year of £131,000 is £24,890.
These calculations assume that the expenditure qualifies for the standard 18% rate of WDA and that the assets are not the subject of a short-life assets election.
Expenditure on certain items (assets with a predicted useful life of at least 25 years, integral features, thermal insulation and certain cars) only qualifies for a 6% reducing balance WDA. If that applied to the illustrative £500,000, the reduction in the Corporation Tax liability for the year to 31 March 2021 would be under £15,000 and it would take more than another 30 years for the company to receive tax relief on 90% of its outlay.
6. If the expenditure was delayed until after 31 March 2021 (so into the company’s accounting year to 31 March 2022), the company’s AIA limit for the full year would be £200,000. The 18% WDA on the remaining £300,000 would give an allowance of £54,000. Corporation Tax relief at 19% on the combined allowance for the year of £254,000 is £48,260.
7. All calculations in this release assume a Corporation Tax rate of 19% which will be the rate until 31 March 2022 (see GOV.UK). If there was a significant increase in the rate after that date, it would reduce but be very unlikely to eliminate the impact of timing decisions about qualifying expenditure.