Capital allowance rules in tax law set out the extent to which deductions from profits are allowed in relation to capital expenditure. The basis is different from the way capital expenditure is allowed in financial accounts, which use depreciation charges to spread the capital expenditure out fairly over time.
The tax treatment of capital allowances was formely broadly similar in the United Kingdom and Ireland. However, the system of capital allowances was reformed radically in the period 2007 to 2011 so that there are now more pronounced differences.
The general principle is that depreciation is not allowed as a deduction and is accordingly added back to the profit figure, in computing taxable income. Capital expenditure is deductible only if it qualifies in accordance with the Capital allowance rules. Even which it is deductible, the deduction is allowed at a stage in the computation after-tax adjusted profits have been ascertained.
Some capital expenditure is never allowed as a deduction. Other capital expenditure is allowed but on more restrictive terms than would apply in depreciation under financial accounts.
Capital allowances and tax allowances have been used in Ireland in the past so as to stimulate investment in property and other assets in a way that has not been replicated to the same extent in the United Kingdom. There have been more limited instances of incentive capital allowances.
Capital Allowances for Plant and Machinery
There are capital allowances are for plant and machinery, (f0rmerly for industrial buildings) and various types of research and development expenditure.
Machinery is usually easy to identify and will include cars, computers and office equipment. Plant is a more general concept that is not specifically defined by tax legislation. Plant mean apparatus with which the business is carried out. It does not include a “setting” so therefore would not include a building. Expenditure and computer software are deemed to be plant.
Land and buildings are not “plant”. Special systems within a building which provide for the particular requirements of the trade, as opposed to the purpose of the building generally may qualify as plant. Manufacturing and processing equipment, storage equipment, cookers, washing machines, basins, furniture and fittings, partition walls, sprinklers, and decorative assets in a hotel may qualify as “plant” in their particular context.
Capital allowances are not calculated on individual assets. They are put in a general pool and when an addition is made, the pool increases and when an asset is disposed of, it decreases. Some classes of assets are pooled together.
The allowance on certain assets are restricted, irrespective of their actual cost, for example, the cost of motor cars over a certain amount are not included.
Capital allowances are allowed in relation to certain types of research and development. The activity may only qualify if there was innovation and creativity in science and technology and it is relevant to the business.
Reformed Allowances System
Since 2008, all businesses were given an annual investment allowance on the first £50,000 of expenditure on plant and machinery. There is also a tax credit for expenditure on certain environmental friendly technology. Since 2016 the annual investment allowance is £200,000.
Allowances are given on
- 100% of annual expenditure up to £200,oo0 on most types of plant and machinery;
- 100% on most energy saving or environmentally friendly beneficial plant and machinery;
- 100% for new low emission cars for use of directors or employees
- 100% of new electric vans;
- 18% for higher emission cars (reduced to 8% where emission exceed a further threshold),
Thereafter, any unallowed expenditure is written down on a reducing balance basis, generally at 18% p/a.
The following are placed in separate pools
- plant and equipment (including vehicles) with CO2 emissions below a specified amount
- cars with CO2 emissions above a specified amount
- assets with mixed business and personal use
- short life assets (see below).
The rate is 8% p/a for cars with emissions above a specified amount.
Capital Allowances for Plant and Machinery
An annual investment allowance is allowed. Subject to this, An annual writing down allowance of 18% (formerly 20% and 25%) is given on a reducing balance basis. The allowance is given by reference to expenditure in the period on the “tax written down value” brought forward at the beginning of the period. The “tax written down value” includes all prior expenditure less allowances previously claimed and used. When the balance is reduced to £1,000 it can be relieved in full.
Allowances are given for a period of account. The percentage is relief based on an accounting period of 12 months. Where the period is shorter, this pro-rated.
The writing down allowance applies to all assets in the pool on the last day of the period of accounts. Therefore where business accounts are made up to the 31st March, the writing down allowance is given for assets in the pool on that day, irrespective of whether the asset is purchased at the beginning or last day of the period.
Where an asset in the pool is sold, it is removed from the total tax written down value brought forward in the pool. The writing down allowance for the period is calculated on the remaining figures. The amount deducted from the pool is the lower of the sale proceeds or the original cost.
If on the disposal of an asset in the pool, the proceeds exceed the brought forward value in the pool the excess allowance previously given or recovered is charged to tax by means of a balancing charge. A balancing charge is taxed as an addition to trading profits.
Balancing allowances arise when the sale proceeds are less than the written down amount for the asset in the pool. Where a business is permanently discontinued and there is still an unrelieved expenditure, the business can claim relief for the unrelieved balance.
Where assets are used partly for business and partly for non-business purposes the capital allowances must be pro-rated in proportion to the respective uses
It is possible to elect to treat assets as “short life” assets where the intention is to sell them or scrap them within 4 years. In this case, each short life asset is subject to separate capital allowance computation. If disposed of within the four years, a balancing allowance or a balancing charge arises relative to the written down amount. If no disposal is made within four years, the unrelieved balance is transferred back into the pool.
Capital Allowances for Industrial Buildings
Capital allowances for expenditure on industrial buildings are no longer available. The allowance was progressively reduced from 1 April 2008 for companies and from 6 April 2008 for income tax cases. Both of these allowances were withdrawn from April 2011.
Capital allowances for buildings were only available to buildings used for a “qualifying trade”. A qualifying trade is one carried on in a mill factor or similar premises or for the manufacture of goods or materials by subjecting them to processes or for the storage of goods of materials used for manufacturing which are to be subject to processed finished goods which have been manufactured
The effect of the above is that capital allowances were only available for what would broadly be described as factories or hotels. They were not available to retail premises, offices and other commercial properties. In effect, the capital expenditure on such buildings was not allowed as a tax deduction. The interest on the acquisition finance might have been allowed as a deduction.
There is case law very similar to that applied in Ireland in relation to the drawing of the line between an “industrial” building and other buildings. Dwellinghouses, retail premises and offices are specifically excluded. Hotels werre subject to certain conditions including that they must be open at least four months in the 1st April to 31st October season, have at least 10 bedrooms and provide certain minimum services.
The cost of an industrial building allowed for tax deduction included only the expenditure incurred on construction. The cost of land did not qualify. Where part of a building was used for a non-qualifying purpose, it was ignored if less then 25% and pro-rated if more than 25%. Where buildings were acquired after construction but before use, there were special rules for computing the eligible expenditure.
Writing down allowances was allowed on a “straight line” basis (same amount each year) at 4% per year. This is reduced if the period of account is less than 12 months proportionally. Temporary non-use does not affect the allowance.
Industrial buildings have capital allowance life of 25 years. No allowance or charge will rise in the sale after 25 years.
Where a building is disposed of within the 25 year tax allowance period and the proceeds are less than the “written down” value, a balancing allowance is given. This is a further allowance to reflect the fact that the actual cost is less than the allowance which is made. Where the disposal proceeds exceed the tax written down amount, a balancing charge will arise. This effectively reclaims the excess allowances previously given to the extent that the allowances given, exceeded the difference between cost and sale price.
Where buildings are being used for a non-industrial purpose at the end of the reference accounting period no witting down allowance, is given. There is notional writing down but it is not allowed by way of deduction from the trading profits.
A purchaser of a second-hand industrial building is entitled to industrial building allowance where it is within its original 25 years tax life. Provided the subsequent purchaser uses it in a qualifying trade he is entitled to writing down allowance on the lower of the purchase price or the capital allowance amount.
The annual writing down allowance is computed by spreading the allowance over the remaining tax life. The allowance is the written down value of the building prior to the sale plus balancing charge. This sum is then written off over the remaining part of the 25-year tax life.
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