Since the introduction of the Annual Investment Allowance (AIA), the level of Capital Allowances (CAs) on offer from the government has been, in tax terms, incredibly generous when viewed from a small business point of view.
Prior to the introduction of the AIA, over the preceding quarter century the amount of “First Year Allowances”, encouraging businesses to invest in new plant and machinery, had been somewhat erratic; varying from nil, to 40%, to occasionally 100% when the government wanted to push a particular agenda. This could occasionally lead to somewhat skewed business decisions, when the tax tail was allowed to wag the business-decision dog, as firms large and small suddenly felt the need to bring forward or delay certain investment decisions to take advantage of the reliefs before they vanished.
A certain degree of stability for routine investment in plant was brought in with the introduction of the AIA in 2008, which gave businesses a monetary allowance on which they could receive 100% of their investment as an allowance in the year of expenditure (subject to a few minor rules concerning bringing the asset into use and AIA not being allowed in the year that a business ceases). Although the monetary threshold was modest to start with, since January 2013, the level of the AIA was increased to £250,000 for 15 months, followed by 21 months at £500,000, before reducing to its current level of £200,000 (from 1 January 2016). For a lot of small businesses, having an annual allowance of this level of investment into new (or replacement) plant and machinery allows a simplified approach to the tax relief available – business owners can invest in their new equipment knowing that they will receive full tax relief in the year of investment if they keep within these limits. A writing down allowance still remains for investments above the AIA or for assets excluded from the relief, such as cars.
But there can be a catch for the unwary.
Although for many assets you may be obtaining full tax relief in the year of investment, the allowance is still broadly calculated so that you only actually receive tax relief on the amount of cost or depreciation that you incur whilst you own the asset. When you dispose of the asset, there can be a claw-back of excess relief previously given, particularly on cessation of a business, or if the capital allowances pool has a low carrying value. For example, let us say Joe starts as an independent lorry driver and initially business is very good. He purchases his initial articulated tractor unit for £100,000 and a second one a year later for another £100,000, claiming 100% AIA thereon in both years. Unfortunately, the business did not succeed and our erstwhile lorry driver suffers substantial losses due to damaged loads in his third year. In order to pay back the bank from which he has borrowed, he sells both trucks for £35,000 each and ceases trading. In his final set of accounts, the sale of the two trucks generates a taxable income of £70,000, potentially making Joe a higher-rate taxpayer, even though he sold them at a loss and second-hand. The reason for this is that Joe had previously received tax relief of £200,000, and HMRC are merely adjusting the relief given from what has been claimed, to the actual level of relief afforded by his actual loss on the two trucks.
The claw-back of relief given earlier – sometimes claimed across many years previously – is now becoming an increasing sting to watch out for when a business seeks to generate cash by selling off assets it no longer needs. The tax bill triggered by selling assets can come home to roost anything between 10 and 32 months after the event for the self-employed (depending on your annual accounting date and when in your accounting period that you sell the assets) – potentially even more if you are changing your accounting year end at the same time. An increase in your profits due to Capital Allowance charges can also affect advance payments on account under Self-Assessment.
When a business ceases, any assets still owned as at the date of cessation are deemed to be sold at market value potentially triggering unexpected profits and affecting any terminal loss relief claims as well for the self-employed/partners of the business
There is no avoiding the sting as such, as it is a result of a mathematical adjustment between the tax relief that has been granted and the relief to which you are ultimately entitled. However, by planning for the sting, calculating the effect of selling the business assets in advance, you can potentially split the sales up so that charges, when they come, are dissipated and potentially absorbed into different tax years
Oh AIA – where is thy sting now?
For further information on any of the above points or to discuss your tax affairs generally, please do not hesitate to contact Robin Beadle.