Capital Allowance and Trading Losses Flashcards
What are Capital Allowances, why do they exist?
A government-approved system to deduct capital expenditure (e.g., machinery, equipment) from taxable profits over time.
Key Purposes:
Tax Relief: Offsets capital costs to encourage business investment.
Consistency: Replaces subjective accounting depreciation with fixed rates (e.g., 18% WDA).
Economic Tool: Allows government to incentivize sectors (e.g., green energy via 100% ECA).
EU Compliance: Avoids illegal state aid (e.g., Apple vs Ireland case).
Example: Buying a £50K van → claim £9K/year (18% WDA) → reduces taxable profit.
What are the Fundamental Tax Rules on How Capital Exp. is treated in Tax Calculations
General Rule: Capital Costs can’t be directly deducted from trading profits
Depreciation: Added back to accounting profit (not deductible).
Solution: Claim capital allowances as a trading expense.
Example:
Accounting profit: £100K
Add back £5K depreciation → £105K
Deduct £10K capital allowances → £95K taxable profit.
Who sets Capital Allowance Rates and Why?
Set by Government: Rates (e.g., 18% WDA, £1M AIA) are fixed, not determined by companies.
Reasons:
Prevents manipulation of depreciation methods.
Ensures fair tax treatment across industries.
Allows policy adjustments (e.g., boosting EV adoption).
Contrast: Accounting depreciation = company’s choice; tax depreciation = HMRC’s rules.
How can Capital Allowances clash with EU Rules?
EU State Aid Rules: Ban selective tax breaks for specific companies.
Case Study: Apple vs Ireland (2016):
Ireland’s special 1% tax rate for Apple = illegal state aid.
Capital allowances avoid this by applying universally to all businesses.
Key Point: Capital allowances are compliant because they’re non-discriminatory.
What are the 4 advantages of Capital Allowances
Investment Incentive: Reduces net cost of equipment (e.g., £1M AIA).
Predictability: Fixed rates simplify tax planning.
Policy Flexibility: Government can adjust rates to steer the economy.
Global Compliance: Aligns with international trade regulations.
Real-World Impact: A manufacturer buys £800K robots → claims full AIA → £0 taxable profit that year.
What Types of Capital Expenditure Qualify for Allowance
Plant & machinery (most common)
Integral features (electrical systems, lifts)
Structures & buildings (limited, via SBA)
Excluded: Land, stock-in-trade, leased assets
How is ‘Plant’ legally defined?
Yarmouth v France (1887):
“All apparatus used permanently in trade, except stock for resale.”
Examples: Factory machines (✅) vs. office décor (❌)
What is the Functional Test
Asset must be essential to trade operations, not just part of the setting.
Key Cases:
Wetherspoons (2008): Bar décor = setting (❌)
Dixon v Fitch (1975): Petrol pump canopies = plant (✅)
Gunfleet Sands Case (2022)
Ruled £48M wind farm studies = “plant”
Established: Studies affecting design = functional (even if indirect)
Preparatory studies can be “plant” if linked to operational assets
Broadens definition of qualifying expenditure
How are Allowances Calculated
Annual Investment Allowance
Writing Down Allowance
What is Annual Investment Allowance (AIA)
£1 million annual limit: Full deduction for qualifying assets in year of purchase (Jan 2019-present)
Qualifying assets: New and used plant/machinery (e.g., tools, equipment, vans)
Key exclusions:
All cars (even electric)
Assets gifted or bought from connected parties
Items already owned personally
Strategic importance: Claim AIA before other allowances to maximize immediate tax relief
Example: Restaurant buys £950K kitchen equipment → £950K tax deduction in Year 1
What is Written Down Allowance, how does it work?
Two pool system:
Main pool (18%): Standard business assets
Special rate pool (6%): Long-life assets, integral features
WDV calculation:
Opening WDV
+ Additions not covered by AIA
- Disposal proceeds (up to original cost)
- Previous WDAs
= Closing WDV
Partial year rule: 18% becomes 1.5% monthly for short/long periods
Example: £100K main pool + £50K new assets → Year 1 WDA = £27K (18% of £150K)
How doe Different Accounting Periods Affect Claims?
Sole traders: Can choose any year-end (max 18 month period)
Companies: Must use 12 month periods
Time-apportionment:
6 month period = 9% WDA (half of 18%)
15 month period = 22.5% WDA
Planning tip: Align purchases with period length to optimize timing
Example: Start-up with 15-month first period gets 22.5% WDA instead of 18%
Disposal rules of Plant and Machinery
Golden rule: Never deduct more than original cost
Special cases:
Part-exchange: Use market value if higher than trade-in
Insurance pay-outs: Treated as disposal proceeds
Gifts: Deemed proceeds = market value
Records required:
Original purchase invoices
Disposal contracts
Calculation of balancing adjustments
Example: Sell £50K machine after 3 years:
Original cost: £50K
WDV: £30K
Sale price: £40K → Deduct £40K (but only £30K affects WDV)
What’s the Special Rate Pool?
What specific assets go in the 6% pool
Integral features (electrical systems, lifts, heating)
Long-life assets (>25yrs if spend >£100K/year)
High-emission cars (>50g/km)
Partial year rule: WDA time-apportioned for periods ≠ 12 months
Example: £100K main pool WDV → £18K deduction (18%) On a reducing balance
What constitutes as an Integral Feature?
“Assets that are part of the building but function as plant”
Complete list:
Electrical systems (including lighting)
Cold water systems
Space/water heating
Ventilation/air conditioning
Lifts/escalators
External solar shading
Car Allowance Regulations Types
Category CO2 Allowance Pool Notes
Electric 0g/km 100% FYA N/A No WDV tracking
Plug-in hybrid 1-50g/km 18% WDA Main Must have 10+ mile range
Diesel >50g/km 6% WDA Special rate Includes most SUVs
Real-world impact: £50K Tesla = £50K deduction; £50K Range Rover = £3K/year
Long-Life Asset Threshold
When does the 6% rule apply?
Automatic 6% if:
Expected useful life >25 years AND
Spend >£100K on such assets in period
Common examples:
Industrial generators
Turbines
Specialized manufacturing equipment
Documentation needed: Engineer’s lifespan certification
Planning tip: Bundle purchases to stay under £100K/year threshold
Short-Life Asset
When should this be applied
Benefits:
Full write-off if scrapped/sold within 4-8 years
Avoids being trapped in main pool
Ideal candidates:
Computers/tech (3-5 year lifespan)
Restaurant equipment
Retail fixtures
Process: Must elect within 2 years of purchase
Example: £20K computer system → full deduction if replaced in Year 4
Mixed Asset Purchase Example: How to Calculate Allowances for
£1.2M total spend
Includes £200K ineligible for AIA
15-month accounting period
AIA: £1M deduction (max)
Remaining £200K:
£50K long-life assets → 6% pool (£3K WDA)
£150K standard equipment → 22.5% WDA (£33.75K)
Total deductions: £1M + £3K + £33.75K = £1.03675M
Some Assets can’t join the main pool
Non-pool assets include
Part-Business Use Assets (Not wholly used for business)
Must track separately from other assets
Only claim business-use % (e.g., 60% work car → 60% of allowances)
Short-Life Assets
Election available for assets replaced in 4-8 years
Enables full write-off if disposed within timeframe
Complex rules on qualifying items
Example: £10k laptop (80% business use) → £8k added to short-life election
What classifies as Structures & Buildings Allowance
Qualifying Structures:
Factories, warehouses, offices
Bridges, tunnels, walls
Excludes: Land, residential, planning fees
Calculation:
3% straight-line of construction cost
Time-apportioned for partial years
Global application (if UK-taxed)
Example: £600k warehouse owned for 9 months → £13.5k allowance (600k × 3% × 9/12)
What qualifies for 100% Enhanced Capital Allowances
Very limited categories:
EV charging stations
Gas refuelling equipment
Energy-saving boilers
Key Features:
100% deduction in first year
Claim before AIA/WDA
Not pooled - immediate write-off
Example: Install £15k EV charger → £15k full deduction
What’s the Order of Treatment for Claiming Allowances when Tax Planning
ECA (100% green assets)
AIA (£1m general equipment)
Separate Pools (cars, part-use assets)
WDA (18%/6% on remaining balances)
SBA (3% buildings)
Strategy Tip: Maximize immediate deductions first to accelerate relief
How is a trading loss calculated for tax purposes?
Start with accounting profit
Add back: Disallowed expenses (e.g., depreciation, client entertainment)
Remove: Non-trading income (e.g., rental income)
Deduct: Capital allowances
→ Negative result = Trading loss
Key Point:
Possible to have an accounting profit but a tax loss due to adjustments.
Example: £50K profit + £20K disallowed expenses - £80K allowances = £10K loss.
How can Trading Losses be Relieved (ITA 2007 Rules)
Current/prior year offset (s64):
Deduct from general income (salary, dividends) for:
Current year, or
Previous year (claim refund), or
Both years.
Restriction: Max £50K or 25% of income (whichever higher).
Carry forward (s83):
Offset against future trading profits (indefinitely).
Condition: Must be same trade.
Commerciality Test: Losses only allowed if trade is not a hobby.
Tax Planning with Losses
When should you delay Capital Allowances to create/ manage losses
Good scenarios:
Higher future tax rates: Carry forward losses to offset profits taxed at 40% vs. 20% now.
Protect personal allowance: Use losses to reduce income below £100K (where allowance tapers).
Startup cash flow: Claim loss relief against prior years’ income for refund.
Example:
Year 1: £30K loss → carry back to Year -1 (refund).
Year 2: £60K profit → use remaining loss to reduce tax.
Opening Year Loss Relief (New Businesses)
How can new businesses use losses in first 4 years?
Special rule: Losses in first 4 years can be offset against:
Total taxable income from 3 prior years (earliest first).
Why?: Helps startups with initial investment costs.
Example:
2024: Start business, £40K loss.
2021-2023: Paid tax on £20K salary/year.
Claim: Offset £40K against 2021-2023 income → HMRC refunds taxes paid.
Condition: Trade must be commercial (not hobby).
