Capital Allowances and How they Work?

What are capital allowances?

Expenses incurred in a business are either capital or revenue expenditure. Revenue expenses are normally for day to day costs such as stationary, or in a property context repairs such as reparing and paintint a wall. Capital expenditure is usually expenditure on items which provide an enduring benefit for the trade. By enduring benefit we normally count a life span of two years as a minimum. Capital expenditure is not automatically deductible from trading profits, so a measure of tax relief is received in the form of Capital Allowances. According to Curtis Plumstone Associates a clear definition of capital allowances is, ‘A Government Tax Incentive to Invest in Plant and Machinery’. This incentive reduces taxable profits by claiming tax relief on certain types of capital expenditure (plant and machinery) to reduce taxable trading profits.

Capital allowances are also available to those who have incurred qualifying capital expenditure on the construction, fit out, refurbishment or acquisition of commercial property within a trade. This can include offices, hotels, restaurants, retail, industrial, mixed use developments and various others.

Commercial property let out to a third party can also attract a claim for capital allowances. This can include property both in the UK and abroad provided the company or individual pays tax in the UK.

Does all capital expenditure qualify for capital allowances?

Not all capital expenditure qualifies for capital allowances. The company/individual claiming the capital allowances must own the asset. Provided the property is held as a fixed asset and not stock, expenditure on the installation of Plant and Machinery (including any demolition costs) will qualify for capital allowances. Plant & Machinery, in the context of property, includes items such as electrical sytems, heating systems, hot & cold water systems and sanitary ware

Please be aware that expenditure on hire purchases, finance leases and cars have a different set of capital allowances rules.

How do I claim capital allowances?

Capital allowances must be calculated and claimed in a tax return. However, there is no time limit on claiming capital allowances, as long as the asset is still owned and used within the trade.

We advise when building, acquiring or completing refurbishment projects on a property, capital allowances are considered at the earliest stage. This will help to maximise the tax benefits. For example solicitors should be advising any potential purchaser of a commercial property to consult a Capital Allowances Specialist such as Curtis Plumstone Associates well before exchange of contracts.  

What are Integral Features?

Integral features were introduced in Finance Act 2008. They are fixtures within a building which typically provide a longer lasting use and are harder to remove from the property. Integral Features include: Lifts, hot and cold water systems, heating and ventilation systems, electrical lighting and power systems and external solar shading. Currently, Integral Feature receive the writing down allowance (WDA) of 6% per annum.

For example if you have a qualifying integral features asset with a value of £100,000 in the first tax year, you will claim 6% (£6,000) of allowances and have a balance of £94,000 in the pool to carry forward. In the second year you will claim 6% of the residual balance and carry forward the remainder. This is repeated until all the allowances are fully utilised or the asset is sold/no longer in use.

What are fixtures?

As defined by the Capital Allowances Act 2001 plant and machinery fixtures are fixtures that have been installed/fixed in a property so as to become legally part of the property. Ownership of these “Plant and Machinery Fixtures” passes to the new owner of a property once sold.

So even though “plant and machinery” would include tables, chairs etc. they would not be categorised as fixtures. They are known as chattels or movables and by their nature are not legally part of the property.

What rates are capital allowances given on plant and machinery?

The rates for capital allowances depend on the type of capital expenditure incurred and the date that it was incurred on.

The writing down allowance that is currently given to general pool allowances is 14%, whereas the special pool writing down allowance is 6%. The Annual Investment Allowance and First Year Allowances are far more generous allowance, giving 100% of a certain limit of expenditure within a year.

Example: If you have a qualifying general pool asset with a value of £100,000 in the first tax year you will claim 14% (£14,000) of allowances and have a balance of £86,000 in the pool to carry forward. In the second year you will claim 14% of the residual balance to give allowances of £12,040, carrying forward £73,960. This is repeated until all the allowances are fully utilised or the asset is sold/no longer in use.

What is the Annual Investment Allowance?

The Annual Investment Allowance (AIA) provides 100% tax relief on qualifying plant and machinery up to set expenditure limit within a year.

The business/individual can choose how to allocate the AIA.  However, allocating it to Integral Features first, obtains the fastest tax relief; as these allowances would otherwise attract the lowest writing down allowance of 6%.

The AIA is available to all businesses but only one AIA is available each year. Partnerships where all members are individuals and sole traders are also entitled to an AIA.

No AIA is available for plant and machinery acquired from ‘connected persons’ or for assets brought into use which had been previously owned by the company/person and used for other reasons.

The Annual Investment Allowance is also time apportioned if an accounting period is more or less than 12 months.

The current Annual Investemnt Allowance is £1m which has been the case since the 1st January 2019.

What is Full Expensing?

Where a company incurs capital expenditure on assets that would otherwise qualify for the main pool (such as most loose plant and machinery, furnishings, manufacturing equipment, IT equipment and capital investment on software) it is entitled to claim a first year allowance and take a 100% in year deduction in respect of the expenditure.

So, for example, where a business would otherwise have a £1m tax liability, if they were to incur £2m of qualifying expenditure on a new production line then, by claiming the full expensing first year allowance, they could reduce their tax liability by up to £500k assuming a Corporation Tax Rate of 25%.

Special rate first year allowance

In addition, for assets that would otherwise qualify for the special rate pool (such as electrical systems, lighting systems and long life assets) a 50% first year allowance is available (with the balance being introduced into the special rate pool as normal). When compared with the ‘normal’ 6% writing down allowances for such expenditure, this is a significant acceleration. In addition the Annual Investment Allowance may also be claimed before the Writing Down Allowance is applied.

What are First Year Allowances?

First Year Allowances (FYAs) attract a100% tax relief on qualifying plant and machinery in the accounting period in which the expenditure has occurred. The following types of expenditure qualify for FYAs:

• Enhanced Capital Allowances (ECAs) – energy efficient plant and machinery which has to qualify according to the Government Energy Technology list. ECAs have ended from April 2020. However a retrospective claim can currently still be made
• Electric Vehicle charging points
• Zero emission goods and vehicles
• Cars with certain C02 emissions

Unlike writing down allowances, if the accounting period is longer/shorter than 12 months, FYAs are not time apportioned. The assets must not be second hand or they will not qualifying for FYAs.

What happens when I purchase an asset but cannot get Annual Investment Allowances (AIA)?

If an asset qualifying for Capital Allowances is purchased but the AIA has been fully utilised then the expenditure will be treated under the standard capital allowances rules and receive a writing down allowance of either 14% or 6%.

Can capital allowances be claimed on investment property?

You can claim capital allowances for plant and machinery in a commercial investment property. For residential investment properties, you cannot claim capital allowances within a dwelling (in line with legislation) unless they are a serviced apartment or qualify as a furnished holiday let. However a claim for plant and machinery within the communal areas of an apartment blocks is possible provided the property is held as an investment. This includes assets such as lifts, carpets, lighting and fire alarm installations within corridors and communal areas.

Can capital allowances be deferred/carried forward?

You can defer capital allowances in whole or in part (if it is not beneficial to claim all the allowances), and claim the residual allowances in future years.

However there can be disadvantages of not claiming capital allowances in the year the expenditure is incurred as you may miss out on fully utilising the 100% Annual Investment Allowance.

Can capital allowances create loss?

If a business is loss making, claiming capital allowances may create further losses for the year. You can elect to carry back the loss for the previous 12 months of trade, assuming the business was profitable. For post April 2017 losses, you can elect to carry forward losses to be off set against future trading profits.

Can capital allowances be carried back?

Capital allowances cannot be carried back. However if the result of claiming capital allowances created a trading loss, the loss created may be carried back to the previous 12 months of trade, assuming the business was profitable. There is also the option to amend a previous year’s tax return and submit a capital allowances claim (as long as it is within the time limit to amend).

Capital Allowances When You Sell an Asset

When you have claimed capital allowances on a moveable asset / plant and machinery (such as furniture and white goods) you are required to recognise a disposal value on sale of the asset. The disposal value typically equates to the proceeds attributed to the movable asset agreed between the Seller and Buyer, restricted to the original cost.

Similarly when you have claimed capital allowances on fixed assets / plant and machinery within a commercial property (such as the air conditioning, electrical installations and sanitary installations), you are required to recognise a disposal value on sale of the commercial property. Again the disposal value typically equates to the proceeds attributed to the fixed assets agreed between the Seller and Buyer, restricted to the original cost. However, unlike moveable assets, as the Seller of fixed plant and machinery, you are able to agree a CAA 2001 s198 tax election. The tax election will enable you to agree a disposal value figure between the original cost of the fixed plant and machinery and a minimum of £1. This mechanism only available in the UK for fixed plant and machinery, enables you to retain the capital allowances claimed on fixed plant and machinery on sale of a commercial property.

Are Capital Allowances the same as Depreciation?

Depreciation is an accounting adjustment to recognise the decrease in the value of an asset (movable or fixed assets) over time due to wear and tear and obsolescence. It is non-deductible for tax purposes. However, capital allowances are essentially a tax deductible version of depreciation. Capital allowances are the means by which a tax deduction is obtained overtime for some qualifying assets (moveable or fixed to property).

What are the Structures and Buildings Allowances?

The Structures and Buildings Allowances (SBAs) were introduced in Finance Act 2019, providing tax relief on a straight line basis of 3% for expenditure (excluding general pool, special rate pool and revenue expenditure) incurred on commercial property construction contracts awarded on or after 29 October 2018.  SBA allowances can be claimed on works including structures, walls and ceilings etc. where previously no tax relief could be claimed. However it is important to note that the timing of claiming SBAs is dependent on several points, including when the works undertaken to the property are brought into use.

SBA’s are not available on residential premises which includes dwellings, student accommodation, aparthotels and prisons.

It is also important to consider that if SBA’s are claimed, there will be a deduction in the base cost of the amount claimed for Capital Gains purposes if you sell the property as an asset. This will therefore increase the amount of Capital gains to be a paid.

Working out capital allowances

Where information is missing or incomplete it can be complex to work out and to calculate capital allowances. A capital allowances specialist can assist to value the allowances available in complex cases.

Curtis Plumstone Associates are an independent specialist firm of capital allowance valuers and can be contacted via their website at curtisplumstone.com

Key capital allowances takeaways are:

Capital allowances provide an absolute tax saving on qualifying plant and machinery. The sooner capital allowances are considered and claimed, the greater the chances of obtaining faster tax relief.

It is important to review historical expenditure as allowances can be claimed on assets that are still owned and a specialist can help identify potential savings even if the information is not of a high standard.

When it comes to selling or buying a property, capital allowances are often over looked and it is beneficial to get advice early on to establish the capital allowances position and avoid any problems later on. If you are in this position contact John Plumridge directly on either jplumridge@curtisplumstone.com or 07779 756213