M6: Capital Allowances

Question 1

How is capital expenditure treated when calculating the tax adjusted trading profits for a business?

Answer 1

When calculating tax-adjusted trading profit, accounting depreciation is added back and capital allowances are deducted.

Mainly plant and machinery allowances and
structures and buildings allowances.

Question 2

What is the purpose of capital allowances?

Answer 2

The aim of capital allowances is to provide businesses with deductions for the net cost of qualifying assets. (tax depreciation)

The net cost is calculated as the purchase price on
acquisition minus the disposal proceeds upon sale.

Question 3

What type of expenditure qualifies for capital allowances?

Answer 3

Expenditure that qualifies for plant and machinery allowances generally includes:
* Vehicles
* Machinery
* Office furniture
* IT equipment
* Other movable plant and machinery items

Plant and machinery allowances can also be claimed for the cost of:
* The alteration of a building to install plant and machinery.
* Demolition costs related to removing or demolishing plant and machinery.
* Thermal insulation of buildings.

Question 4

How much expenditure is eligible for capital allowances computations?

Answer 4

Allowances are given based on the cost of the qualifying capital expenditure incurred by the business. If a portion of the cost is covered by a grant, capital allowances will not be available for the part of the cost covered by the grant.

If a business is able to recover VAT paid on business expenditure, then the VAT recovered is not
considered a cost to the business. In this case capital allowances are claimed on the asset’s cost net
of VAT.

If a business is not able to recover VAT paid on business expenditure, then the VAT which is not
recovered (the irrecoverable VAT) is considered a cost to the business. In this case capital allowances
are claimed on the asset’s cost including the VAT paid and not recovered.

Question 5

When can a business claim capital allowances?

Answer 5

An unincorporated business can claim capital allowances for each accounting period for which it
calculates a tax-adjusted trading profit (or loss) to include in a self-assessment tax return.

The rules allow pre-trading capital expenditure to be
treated as incurred on the first day of trading.

Question 6

How are capital allowances calculated for qualifying plant and machinery?

Answer 6

The rates of allowances depend on the type
of asset, the pool which the expenditure falls within and the date the expenditure is incurred.

E.g. First Year Allowance, AIA, Main Pool, Special rates, Private Use

The basic plant and machinery allowance is currently set at a rate of 18% per annum. This is referred to as the standard (or main pool) allowance.

Question 7

How do you lay out the capital allowances calculation?

Answer 7

TWDV b/f from prior period X
+ Additions qualifying for allowances X 1

• Less disposals (X) 2

= Qualifying expenditure X

Allowances at appropriate rate (X) 3

TWDV c/f to next period X

1. Each addition is analysed to determine whether it qualifies for allowances and, if so, which pool
   it falls into.
2. Disposals are recorded at the lower of cost or proceeds. If an asset is sold for more than its
   original cost, only the cost is removed from the pool.
3. Allowances are granted at the appropriate percentage based on qualifying expenditure. This is a
   reducing balance method of calculation.

Question 8

Clarify these terms TWDV, WDA, AIA, FYA

Answer 8

• Tax Written Down Value (TWDV): This represents expenditure that has not yet received tax relief and is carried forward from one period to the next.
• Writing Down Allowance (WDA): This is the annual allowance claimed by a business for qualifying expenditure. It may be replaced by an Annual Investment Allowance (AIA) or a First Year Allowance (FYA).
• Annual Investment Allowance (AIA): This is a 100% allowance for the first £1,000,000 of qualifying expenditure in a given year.
• First Year Allowances (FYA): FYAs may be available for specific plant and machinery types at a 100% rate in the year of purchase.

Question 9

What happens if the accounting period is not 12 months long?

Answer 9

The writing down allowances are pro-rated accordingly.

e.g. an 8 month accounting period the main pool allowance would be calculated as qualifying expenditure x18% x8/12, or

For a 15 month accounting period the main pool allowance would be calculated as qualifying expenditure x18% x15/12.

Question 10

What is the Annual Investment Allowance (AIA)?

Answer 10

The AIA provides full tax relief (100%) for expenditure on new or second-hand plant and machinery (other than cars) up to £1,000,000 per 12 month accounting period.

Any qualifying expenditure beyond the AIA limit is subject to the writing down allowance rate applicable to that asset.

The AIA can be used for motorcycles, vehicles primarily designed for transporting goods (e.g. vans), or any type of vehicle not commonly used as a private vehicle and unsuitable for private use.

Question 11

What rates of capital allowances are available for cars?

Answer 11

The capital allowances for cars depend on their CO2 emissions.

100% First Year Allowances - 0g/km if new

18% Main pool if second hand 0g/km

18% Main pool - 1g/km – 50g/km

6% Special rate pool - 51g/km and above

Question 12

Which assets are eligible for capital allowances at the special rate?

Answer 12

Cars with CO₂ emissions exceeding 50g/km and integral features.

Integral features include electrical (including lighting) systems, cold water systems, heating systems,
ventilation systems, air cooling or purification systems, lifts, escalators and moving walkways.

Question 13

How can the Annual Investment Allowance be used to improve the timing of capital allowances available to a business?

Answer 13

The AIA can be used against assets which would otherwise be allocated to the main or special rate
pools. A business can choose which assets to allocate the AIA to.

Claim against special rate first rather than main pool. as SR is 6% versus 18% for main pool.

Question 14

When do we put an asset in its own pool in the capital allowances calculation?

Answer 14

If an asset is only going to be partly used for business purposes. e.g. dual purpose private car for director.

Only the business use percentage % of the capital allowances can be deducted when calculating the tax-
adjusted trading profit or loss.

Question 15

What are balancing adjustments?

Answer 15

Balancing adjustments can be either a balancing allowance or a balancing charge.

Used to ensure the correct amount of capital allowances are given to reflect the net cost of assets to the business over the life of an asset in its own pool, or the life of the business if the assets are pooled.

Balancing allowances represent an additional deduction in the calculation of tax-adjusted trading
profits. Balancing charges represent an additional add back in the calculation of tax-adjusted
trading profits.

Question 16

Describe the circumstances that would give rise to either a balancing allowance or balancing charge for the three categories:

• Main pool or special rate pool – trade continues
• Main pool or special rate pool – cessation of trade
• Disposing of assets in a single pool

Answer 16

1. Main pool or special rate pool – trade continues:
   - If qualifying expenditure in the pool(s) is negative after including additions and removing disposals, no writing down allowances will be claimed and a balancing charge will bring the TWDV c/f to nil.
2. Main pool or special rate pool – cessation of trade:
   - A balancing allowance will arise where there is a positive qualifying expenditure in the pool(s) after including additions and removing disposals.
   - A balancing charge will arise where there is a negative qualifying expenditure in the pool(s) after including additions and removing disposals.
3. Disposing of assets in a single pool:
   - A balancing allowance will arise when disposal
   proceeds (or cost if lower) are less than the TWDV brought forward.
   - A balancing charge will arise when disposal proceeds (or cost if lower) are more than the TWDV brought forward.

Question 17

What do balancing allowances/charges represent in the calculation of tax-adjusted trading profits?

Answer 17

Balancing allowances represent an additional DEDUCTION in the calculation of tax-adjusted trading profits.

Balancing charges represent an additional ADD BACK in the calculation of tax-adjusted trading profits.

Question 18

How can a business make the best use of the available capital allowance claims?

(4 tax planning strategies?)

Answer 18

To make the best use of available capital allowance claims, businesses can consider several tax planning strategies:

1. Timing of expenditure: Purchasing plant and machinery towards the end of one accounting period (rather than the beginning of the next) can accelerate the timing of allowances, as they can be claimed a year earlier.

Conversely, selling assets that trigger balancing charges should be done early in the accounting period to extend the period between disposal and charge.

2. Annual Investment Allowance (AIA): AIA should be claimed against assets that would otherwise qualify for the lowest rates of allowances, such as the 6% allowances for integral features (special rate).
3. Capital expenditure on buildings: Examine capital expenditure on buildings carefully to identify any elements that qualify as plant and machinery (e.g. office equipment) or integral features (e.g., lighting, heating, and air conditioning systems).
4. Disclaiming allowances: Businesses have the option to disclaim some or all of the capital allowances for an accounting period which can be advantageous for managing tax-adjusted profits or losses.

However, it’s important to remember that FYAs can only be claimed in the first year of an asset’s purchase, and any unused AIA limit cannot be carried back or forward
to different accounting periods.

Question 19

What is Structures and Building Allowance (SBA)?

Answer 19

The aim of the SBA is to encourage business investments in new commercial structures and buildings, and improvements to existing commercial buildings, by providing tax relief for costs associated with constructing new commercial structures and converting existing premises.

e.g. offices, retail and wholesale premises, bridges, tunnels, factories and warehouses.

Question 20

What costs qualify for SBA and which do not?

Answer 20

Qualifying costs for SBAs include:
- Professional fees related to design and construction, - Site preparation costs,
- Construction expenses,
- Capital fitting out works along with renovation, repair, and conversion costs.

Non-qualifiying costs include:
- Land and landscaping,
- Altering land,
- Planning fees
- Site acquisition fees
- Financing costs

Question 21

How are SBAs calculated?

Answer 21

Where SBAs apply, a flat-rate allowance of 3% per annum is available as a deduction in the tax- adjusted trading profit calculation.

Full relief is therefore spread over a period of 33⅓ years.

Question 22

What are the differences between plant and machinery allowances and SBAs?

Answer 22

1. Plant and machinery allowances are calculated on a reducing balance basis, while SBAs are calculated on a straight-line basis.
2. The AIA cannot be used against expenditure that qualifies for SBAs.
3. SBAs can be claimed from the moment an asset is brought into use - meaning a full allowance
   in the period of purchase is not available if the asset is brought into use partway through the
   accounting period. This is not the case for plant and machinery allowances where a full
   periods worth of allowances can be claimed regardless of when the asset was acquired during
   the period.