Example 1: Comparing AIA with conventional capital allowances (CAA)
There are many technical
aspects to deciding whether a given item of expenditure is a ‘revenue’ or
‘capital’ expense. Simply put, a ‘revenue expense’ pays for something fairly
temporary, such as heat and light, fuel for the company car, or office
stationery. When a revenue expense is incurred for business purposes, it is
deductible immediately, and in full.
A ‘capital expense’, on
the other hand, results in a benefit that will accrue over several years – such
as buying a new company van, desk or filing cabinet. It may not be deductible
at all. Often, however, such items will qualify as ‘plant and machinery’ for capital
allowances as a separate tax deduction, as per the following example.
Ian buys a new laptop, for
use in his consulting business, for £1,000. He expects it to last for a few
years and, as such, it is a capital item. He can claim AIA, or he could claim
conventional capital allowances at the main rate of 18%, if he wished. Ignoring
any other assets he may have:
Annual Investment Standard Capital
Allowance Allowances at (AIA) (£) ‘Main Rate’ of 18% (£)
Year 1 purchase 1,000 1,000
Annual Investment
Allowance (1,000)
Or
Capital Allowances (18%) (180)
Carried forward to next year 0 820
Year 2 Capital
Allowances (148)
Carried
forward to next year 672
Year
3 Capital Allowances (121)
Carried
forward to next year 551
Year
4 Capital Allowances (99)
Carried
forward to year 5, etc. 452
AIA gets immediate 100% tax relief. By contrast, normal ‘main rate’ writing down allowances take four years to get back roughly 50% of the cost (if you think that’s bad, the ‘special rate’ for long-life assets and high-emissions cars is only 8% per annum!).
Clearly, AIA should be claimed where possible (one notable exception is cars, although vans are eligible). And, while the current maximum annual expenditure stands at £500,000, there is more than enough to go around, for most businesses. It is probably also the main reason why tax inspectors have had little appetite for requesting detailed analyses of many businesses’ sundries, office or computing overheads looking for capital items to disallow: if in fact there are any capital items, then they’ll probably rank for AIA anyway.
One of the great things about the AIA is that it basically does not matter when in the accounting year the expenditure is incurred: it could be spread evenly throughout the year or on the last day of the business year and be equally eligible. But that flexibility does not always apply, as we shall see.
Tax trap at the end of 2015
There is a problem for any businesses that have grown used to the generosity of the current regime: the annual thresholds of £500,000 – and the limit of £250,000 before that – were only temporary, and the standard amount was intended by George Osborne to be just £25,000 per year (for the cynics, it is worth noting that, when he cut the standard AIA down to £25,000 in June 2010, the Chancellor stated that the new limit was nevertheless sufficient for more than 95% of UK businesses; makes you wonder why he saw the urgent need to raise it again).
When the AIA threshold changes and a business’ accounting period straddles the change, the part-period with the lower threshold can become extremely restrictive. This will not matter much for businesses with an accounting period ending neatly at the end of December 2015, but other businesses will need to be very careful: not only is the overall maximum eligible expenditure for the year cut down in proportion for the lower threshold after December 2015, the lower proportion caps eligible expenditure completely for the part-period after 31 December.
Example 2 – AIA pitfall
Jonas is a haulage contractor,
with a March year-end. He intends to buy a new trailer unit this business year
at £50,000 but he wants to wait until the final quarter to be sure the business
can support the expense. Knowing that the AIA has been £250,000 and £500,000 in
recent years, he doesn’t understand why his accountant insists he buy it before
the end of 2015. Won’t the new lower limit of £25,000 really only bite in his
2016 period?
Jonas’ accountant
explains:
Overall maximum for the year:
Opening
AIA: £500,000 per annum for April 2015 – December 2015 = 9/12 x £500,000 = £375,000
Closing AIA: £25,000 per annum for January 2016 – March 2016 = 3/12 x £25,000 = £6,250
Overall maximum = £381,250
At this point, Jonas might
be forgiven for wondering what the fuss is about – after all, he wants to spend
only £50,000.
Unfortunately, when the
AIA rate falls, it results in a separate cap on each part-period. And the cap
for the restricted period after December 2015 is the corresponding component
above – i.e. just £6,250 – which means that if Jonas were to wait until his
final quarter to buy his £50,000 trailer, then he would be able to claim 100%
AIA on only £6,250, and have to wait for many more years to deduct the bulk of
the rest.
The new annual rate – already tainted
In his 2015 Budget speech, the Chancellor said that he had been told in no uncertain terms that a reduction in AIA to only £25,000 was simply unacceptable (presumably different advisers to those he had in 2010!), but he has not made up his mind what the new limit will be, from January next year. AIA is expensive: we know that the temporary increase in AIA to £500,000 was expected to cost in excess of £2 billion when it was originally announced, so the Chancellor will be under pressure not to be too generous. But the part of any business’ accounting period after 31 December 2015 is already tainted: it is written into the legislation (FA 2014, Sch 2 para 4 (3)).
If we assume, for example, that the Chancellor is able to support a revised amount of £100,000 from 1 January 2016, a business with a 31 March year-end will still be able to spend no more than £25,000 in its final quarter – 3/12 x £100,000 – for the reasons given in Jonas’ example above. A June 2016 year-end would have to spend no more than £50,000 (6/12 x £100,000) in the final six months of its year-end. A £50,000 cap may be more than enough for many businesses, but it is nevertheless only 10% of the headline amount.
Conclusion and planning
- The key point here is that a business which does not have a calendar business year-end and which is currently contemplating serious capital expenditure should plan to ensure that any amounts eligible for AIA are incurred before the end of 2015.
- In some cases, it may be beneficial to change the accounts ‘year-end’.
- Readers should also beware that the capital allowances regime has its own rules for determining when expenditure is deemed to have been incurred – when the ‘obligation to pay has become unconditional’.
