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1.       Main Rate of Capital Allowances Writing Down Allowance falls from 25% to 20%;

2.       Broadly, assets ‘integrated’ into buildings will only qualify for 10% WDAs;

3.       Long-life assets’ WDA will increase from 6% to 10%;

4.       Introduction of 100% Annual Investment Allowance;

5.       Businesses whose pool values fall to £1,000 or less will be able to claim 100% of the pool;

6.       Enhanced Capital Allowances Credit;

7.       Reduction of Industrial / Agricultural Buildings Allowance from 4% to 3% (FA 2007)

8.       Conclusion and Basic Planning

9.      Appendix – Simple Draft Capital Allowances Computation for the Transitional Period

 

1.          The Main Capital Allowances Pool Rate Falls

i.      The main rate for Capital Allowances will fall from 25% to 20% from the operative date(s) of 1/4/08 (CT) or 6/4/08 (IT). Transitional arrangements are in place to deal with situations where the chargeable period spans the operative date: a ‘hybrid rate’ is created, whereby the effective rate is devised according to the duration of the chargeable period falling before the operative date, and that falling afterwards, by reference to the duration of the aggregate chargeable period.

ii.     The ‘hybrid rate’ is applied to expenditure qualifying for the main pool, regardless of whether it was incurred before or after the operative date, but only insofar as the expenditure didn’t qualify for SME FYAs before the operative date, or the AIA afterwards.

iii.   Small and medium sized enterprises will still be able to claim their FYAs on qualifying expenditure incurred prior to the operative date, and the AIA may be available thereafter.

iv.      ‘Inexpensive’ cars will still be treated as part of the main pool. Expensive cars will still be pooled separately. Cars are not eligible for the new AIA.  The hybrid rate applies for cars whether in the main pool or separate.

v.     Private use restrictions are calculated in the same way as previously, as a proportion of the hybrid rate.

vi.   Not all expenditure which previously qualified for the main pool will do so after the operative date – some will now have to be allocated to the new ‘special rate pool’, as below.

2.          Integral Features Join a Special Rate Pool

i.      From 1/4/08 (CT) or 6/4//08 (IT) expenditure on the following short-listed items – now described as ‘integral features’ of a building – will only qualify for a 10% WDA on a reducing balance basis, and will be added to the ‘special rate’ 10% pool, rather than the main rate (20%) pool:

·       Electrical systems,  including lighting systems – now including basic lighting systems and not just ‘specialised’ arrangements e.g. showroom display;

·       Cold water systems – again this is generally a larger class than previously;

·       Space or water heating systems, air-cooling/purification or ventilation systems, and any floor or ceiling forming part of those systems;

·       Lifts, escalators and moving walkways;

·       External solar shading and active facades;

·       Thermal insulation of all existing buildings used for a qualifying purpose except residential property businesses. (But note Landlords’ Energy-Saving Allowance). Such expenditure normally didn’t qualify beforehand.

ii.     Evidently, the ‘special rate pool’ has effectively widened the scope of expenditure which ranks for Capital Allowances – albeit not by a very great margin, and arguably perhaps in areas where HM Revenue & Customs has frequently suffered at the hands of the courts and the Commissioners.

iii.   One party could sell an older building with assets which would now qualify for WDAs as integrated features, but acquired before the operative date, to another company, after the operative date. Normally, the acquiring party would then be able to claim allowances for those assets – but not if they are connected.

iv.   Some items which previously qualified as plant and machinery under the ‘old 25% regime’ will now fall to be eligible only for the 10% ‘special rate’. Fortunately, it will not be necessary to re-classify relevant items already in the main pool – it doesn’t need to be ‘unravelled’ – even where the expenditure is incurred in the transitional period spanning the operative date, but before the operative date itself.

v.     With that in mind, where such assets acquired before the operative date already ranked for allowances but the relevant property was sold to another party, unlike its predecessor the new party would only be able to claim at the reduced rate. For intra-group transfers (within the same chargeable gains group) there is the option of an election to treat the transfer as being at a price which gives rise to neither a balancing charge nor an allowance, and the acquiring company’s deemed expenditure is allocated to its main pool instead of the special rate pool.

vi.   Thankfully, HM Revenue & Customs has confirmed that ‘electrical systems’ will be interpreted narrowly, so that alarm systems, telecommunications systems, CCTV systems and the like will not be treated as ‘electrical’ – it is basically intended to cover the normal power distribution systems in a building.

vii.  For some assets, such as heating systems, a 10% reducing balance basis will be completely unrealistic. Unfortunately, the legislation prohibits making a ‘Short Life Asset’ election for items which are incorporated into the ‘special rate’ pool.

viii. From the operative date, where more than 50% of any of the integral features shown above is or are replaced in any 12-month period, (by reference to the total replacement cost of the asset in question, in the period of replacement), then that cost cannot be claimed as a revenue expense but must instead be added to the ‘special rate pool’. In effect, this advances a statutory extension to the long-standing principle that the replacement of an asset in its entirety is capital, rather than revenue.

ix.   There will be no ‘hybrid rate’ as such for transitional periods spanning the operative date, so far as integrated features are concerned: no matter how short is the part of the chargeable period after the operative date, the expenditure will qualify for a full 10% WDA. The treatment varies for ‘long life assets’ – see below.

3.          Long Life Assets Join a Special Rate Pool

i.      From 1/4/08 (CT) and 6/4/08 (IT) any unrelieved expenditure on a ‘long life asset pool’, together with any new expenditure on such assets, will be transferred to the new ‘special rate pool’ alongside assets integrated in a building – see (3) above. The ‘special rate’ is of course 10% and this represents an increase in the rate of allowances for long life assets, from 6% beforehand.

ii.     Where chargeable periods span the operative date above, a special ‘hybrid rate’ of Capital Allowances will be used for long life asset pools in that transitional period, as per the main rate pool in (2) above, and from a computational perspective, any remaining unrelieved expenditure will be allocated to the new ‘special rate pool’ from the commencement of the next chargeable period.  A ‘hybrid rate’ isn’t required for integral features because that part of the ‘special rate pool’ didn’t exist before the operative date.

iii.   As with qualifying expenditure on integral features, expenditure on long life assets incurred after the operative date will qualify for the full 10% WDA, even in the transitional period.

4.          The New 100% Annual Investment Allowance (AIA)

i.      The new AIA is available to most companies, partnerships (without corporate members), sole traders and even employees, undertaking a qualifying activity – which includes trades, professions, most property businesses and the individuals in the conduct of their employment.

ii.     It provides a 100% Capital Allowance on most expenditure which qualifies for plant and machinery allowances arising in the chargeable period, up to a maximum of £50,000 a year. This includes plant or machinery which would qualify for either the main or special rate pools – so long life assets are eligible, as are assets for a leasing activity. Cars are ineligible. Once the AIA is exhausted, any remaining qualifying expenditure is allocated according to normal rules – for instance to either the main rate or special rate pools, in most cases. For many smaller businesses, however, the allowance will constitute a complete deduction for all qualifying expenditure and there will be no surplus to allocate.

iii.   The AIA has effect as regards qualifying expenditure incurred on or after the operative dates of either 1/4/08 (CT) or 6/4/08 (IT). The FYA regime for small and medium sized enterprises ceased immediately before then but the new allowance is not a direct replacement – for instance, it is not restricted to small and medium sized enterprises.

iv.   The new AIA complements the remaining FYA schemes – such as Enhanced Capital Allowances, Research and Development Allowances or Business Premises Renovation Allowances. It is possible to allocate the new Allowance to specific qualifying expenditure, so as to ensure it is used most effectively.

v.     The AIA maximum is adjusted on a time basis, so if a chargeable period is less than or more than 12 months, the £50,000 limit is restricted or enhanced accordingly. For the transitional chargeable period which straddles the operative date, the Allowance is similarly adjusted, and only the period from the operative date to the end of the chargeable period accrues AIA.

vi.      The AIA can be applied to assets with private use – as with FYAs, the claim is discounted to reflect the element of private use.

vii.   Groups and Related Businesses – The AIA is also restricted insofar as groups of companies, or companies or unincorporated businesses which are otherwise ‘related’, will have to share a single AIA. This is a special test:

·       Are the companies or unincorporated businesses under common control by a person or persons? (Ignoring ‘connected persons’ or ‘associated company’ rules) and, if so, in a given tax year for unincorporated businesses or financial year for companies,

a.           At the end of their chargeable periods, were those commonly-controlled business’ activities carried on from the same premises, or

b.          Did more than 50% of the turnover of each of those commonly-controlled businesses fall within the same ‘NACE’ classification of economic activities? (Note that these classifications can be quite broad).

·       Note that the test for related businesses doesn’t ‘mix’ companies and unincorporated businesses: there should be one test for related companies and one for unincorporated businesses.

·       Where a single AIA is shared between a group of companies or related businesses, the Allowance may be distributed around that group however the claimant sees fit.

5.          Small Plant and Machinery Pools – Increased Allowances

i.      Legislation should be introduced through FA2008 which will enable businesses to claim a WDA of up to £1,000 on each of the ‘main rate’ or ‘special rate’ pools, once the unrelieved expenditure in a pool has fallen to £1,000 or less. 

ii.     This will end the current regime of writing down continually smaller amounts, year on year, with little tangible economic effect.  Note that, with the advent of the AIA, many smaller businesses may simply not add to their main rate or special rate pools for many years, as they may be able to claim 100% relief on all new additions.

iii.   In line with the general theme of Capital Allowances, businesses will not have to claim the full £1,000 in any particular period, but may defer to whatever extent is required to suit their own particular needs.

6.          Enhanced Capital Allowances – First Year Tax Credit for Companies

i.      From 1 April 2008, companies only will be able to surrender losses attributable to ‘Enhanced Capital Allowances’ (energy-saving or environmentally-beneficial plant or machinery) in exchange for a payable tax credit. The credit isn’t just restricted to trading companies but encompasses companies with property businesses and those with ‘investment businesses’.

ii.     The credit is payable at a rate of only 19% so it will almost certainly be less than the effective marginal rate saving a company might achieve by simply carrying the loss forwards.

iii.   The loss may only be surrendered for credit, to the extent that it cannot be set against the company’s other taxable profits for the chargeable period, or surrendered as group relief.

iv.   The credit is also subject to a limit which is the greater of

a.           the company’s total PAYE/NIC liability for the chargeable period, and

b.          £250,000

v.     There are also provisions to ‘claw back’ the credit, if the plant or machinery on which the corresponding claim to Enhanced Capital Allowances was based, is sold within 4 years of the chargeable period for which the credit was paid.

7.          Phased Reduction of Industrial And Agricultural Allowances

April 2008 also sees the first annual reduction in the straight-line Industrial and Agricultural Buildings Allowances, from 4% to 3%, which will of course continue until both have fully expired.

8.          Conclusion and basic planning

For many small businesses, the advent of the AIA will be extremely welcome: it will indeed simplify Capital Allowances for them, and afford greater relief than previously. There is also some flexibility, so that where expenditure would qualify for other favourable allowances, the AIA can be targeted elsewhere.

For larger businesses, however, the loss of FYAs, and the reduction in general WDAs, will be more of a concern – the lost allowances will significantly outweigh the benefit of the AIA for many.

The timing of allowances in the transitional period will also be critical: taxpayers and advisers will do well to make sure that they are familiar with the specific rules governing when a claim can first be made, (i.e. basically when the obligation to pay becomes unconditional), to ensure that claims fall on the right side of the operative date and higher entitlements are not wasted.

This theme continues for those businesses whose eligible expenditure habitually reaches the AIA maximum: since any such Allowance cannot be carried forwards if unused, it makes sense to ensure that the timing of expenditure is managed from one period to the next – where possible – to ensure that none is wasted.

Bearing in mind that, where expenditure doesn’t qualify for the AIA, it will generally suffer from a lower WDA than previously, it follows that the AIA should be claimed first in respect of qualifying expenditure which otherwise ranks for the lowest rate of allowances.

In a similar vein, and predominantly for unincorporated businesses, assets with an element of private use may be given a lower priority when determining the most efficient allocation of the AIA, as a significant proportion of the AIA could be ‘wasted’ against the private use discount.Where there are groups or other ‘related’ businesses, the most efficient use of the AIA will not just depend on a comparison of the Capital Allowances rates available but also (and more probably) as a product of the marginal tax rate of each business overall. Consider if one company in a group has a Capital Allowances main pool hybrid rate of 22% but is subject to Corporation Tax on its profits at around 21%, whilst another group company has a main pool hybrid rate of 23.5% but is subject to Corporation Tax at a rate of around 30%, then clearly the latter company stands to gain more overall by utilising any available AIA, even though its main pool rate is better on its own. Generally speaking, however, members of the same group of companies will tend to have similar hybrid rates, on the basis that they will have similar accounting reference dates. If so, then a comparison of the companies’ marginal rates should make the matter more straight forward.

There will perhaps be a stronger inclination to make use of ‘Short Life Asset’ elections – noting, however, that this election cannot be applied to assets which belong to the ‘special rate pool’.  

HM Revenue & Customs is also keen to point out that the scope of assets qualifying as integral features will offer greater potential for assets generally to qualify as plant or machinery and thereby be eligible for Enhanced Capital Allowances and a WDA of 100%.

As to simplification, experience suggests that it may not be too long before the dividing line between general plant and machinery, and integrated features, is tested by those businesses for which £50,000 a year just isn’t enough.