Since 1 January 2019, the Annual Investment Allowance (AIA) for businesses has stood at a temporarily increased £1 million per annum. This is the amount any business can spend on most plant and equipment in any financial year and obtain tax relief on the full cost up front.
The permanent AIA limit is £200,000, and the temporary increase was intended to provide an incentive for businesses to invest and grow. The increase is currently due to come to an end on 31 December 2020, at which point it will drop back to the previous £200,000 level.
We now know that there will not be an Autumn Budget, and it therefore appears unlikely that the government will extend the temporary increase, unless this emerges as part of a separate package of measures to help the economy to recover from the aftermath of the Covid-19 pandemic.
If the limit does drop as currently expected, there is a very nasty side effect of the way the transitional rules are written, which we have encountered before as the limit has changed, but this is the biggest AIA drop so far meaning the potential effect is bigger than ever.
Take a business with an accounting year ending on 31 March 2021. As things stand, on a straight time apportionment basis they will get 9/12 of the £1 million limit (for April to December 2020) and 3/12 of the £200,000 limit (for January to March 2021), meaning a “hybrid AIA” of £800,000 for their accounting year. Sounds simple right? Wrong.
The way the rules are written mean that this business can use as much as they want of the £800,000 limit for equipment purchased up to 31 December, but only the part directly related to the final three months for purchases January, February and March 2021 – i.e. a maximum of £50,000.
Traditional year-end tax planning involves looking at accelerating equipment expenditure to try to use up the allowance, but if this business reviews its spend and then buys £800,000 of equipment in March 2021, only £50,000 will obtain full tax relief up front, the remaining £750,000 will only receive relief of 18% per annum (or even 6% for some asset types) going forward. In this example, assuming this is a limited company, the impact on the Corporation Tax liability for the year would be £116,850 more tax than if the money was spent in December 2020 instead, or even more if we are looking at assets only qualifying for the lower 6% allowance.
The effect is even more stark when the year end is closer to the start of the calendar year, so for February and January year ends.
So, as things stand, the advice is to review your capital spend for the year before the end of 2020 rather than waiting for your accounts year end to approach, to make sure you can avoid this rather nasty trap in the transitional rules.
To discuss your situation further please contact James Geary on email@example.com or call 01242 776000.