Capital Allowances - What now after the March spending spree on new machinery?

Recently, many farming businesses will have spent money on new qualifying plant and machinery, in advance of the change to capital allowance rules. These changes took effect from April 2012.

The main headline has been the reduction in Annual Investment Allowance (AIA) from £100,000 to £25,000. The AIA prior to April 2012 provided for 100% tax deduction on the first £100,000 of expenditure per year on qualifying plant and machinery (excluding cars), long-life assets and integral features, although the allowance may need to be shared between related businesses. This relief has been reduced to £25,000 per year from 6 April 2012 for unincorporated businesses and 1 April 2012 for companies. This is a significant reduction and the implications are that it now takes a lot longer to realise the tax savings through qualifying plant and machinery expenditure.

For farming businesses with a year-end of 5 April 2012 (unincorporated businesses) or 31 March 2012 (companies) the position is fairly straightforward, in that the maximum AIA available in the 2012 accounting year should amount to £100,000, which should reduce to £25,000 in the 2013 accounting year and subsequent years.

Hybrid rates apply where the accounting year-end of the business does not coincide with 5 April 2012 (unincorporated businesses) or 31 March 2012 (companies). In these cases time apportionment of the £100,000 and £25,000 limits is required.

For example…

A company with a year-end of 30 September 2012 will have an allowance of £62,500. This is composed from £100,000*1/2 (calculated from the pre- April 2012 AIA) + £25,000 *1/2 (calculated from the post- April 2012 AIA). It should be noted however, that for expenditure incurred after the 1st or 6th April date (1/6 April), the maximum allowance that can be attributed to that expenditure is a fraction of £25,000. The fraction will be the amount of £25,000 that is included in the calculation of the overall AIA for the accounting period.

Supposing this company with the 30 September year end wishes to buy new plant costing £35,000. If they had bought it in February 2012 they would have been able to claim an AIA on the full £35,000, but if they buy it in June 2012, they will only be able to claim an AIA of £12,500 (£25,000*6/12). They will actually therefore be better off if they wait until October 2012 when they will have a full £25,000 available.

Writing Down Allowances

In addition to the reduction in AIA, Writing Down Allowances (WDA) rates reduce from the 1/6 April date. The WDA applies to the rate of capital allowances available on the unused capital allowance pool from the previous tax year and the excess of expenditure over the AIA limit in the year. The main rate of 20% will be reduced to 18% and the lower rate of 10% which applies to integral features and long-life assets will reduce to 8%. It will be necessary to calculate hybrid rates where the accounting period straddles 1/6 April which will give a rate between 20% and 18% (or between 10% and 8% for that period). There are of course practical reasons for changing a machine in a farming business, not simply tax savings, and these will still form part of the decision making process. They might include changing tyres (e.g. it could cost in excess of £10,000 to change flotation tyres all round on a large tractor); the inadequacies of existing assets; and increasing repairs on existing machines.

Capital allowances are not generally affected by the way in which the business pays for the purchase. So, where an asset is acquired on hire purchase (HP), allowances are generally given as though they were an outright cash purchase and subsequent capital repayments are ignored. Finance leases are an alternative method of purchasing an asset, where capital allowances can be claimed. Instead of considering the AIA and WDA rules, the depreciation charged on the machine through the annual accounts is usually allowable as a tax deductible expense.

Any interest or other finance charges on an overdraft, loan, HP or finance lease as part of the asset purchase is an allowable deduction against tax profits in the year. Where a business temporarily rents capital equipment, such as a tractor during silage work for example, capital allowances are not available and instead, the rents are set against the tax profits in the year. This type of arrangement is often referred to as an operating lease.

Beware rules in relation to when the expenditure is treated as having been incurred

Care needs to be taken as there are rules in relation to when the expenditure is treated as having been incurred. Complications can arise where the expenditure is made via hire purchase for example, where allowances are claimed when the asset is brought in to use.

In a scenario where a tractor is purchased, it is normally brought in to use as soon as it has been delivered and the hire purchase agreement will typically be dated at or around this date. When a combine is considered, if it were purchased in March for example, it may not be brought in to use until harvest time later in the year. In this case, if it could not be demonstrated that the combine had been brought in to use, capital allowances could only be claimed on any deposits (would include trade-ins) plus any capital repayments under the hire purchase agreement.

Capital allowances are a complicated area and if you are considering making a significant investment, you should consult with your usual Johnston Carmichael contact to talk you though the accounting and tax implications.

If you would like to discuss this, please get in touch with your usual Johnston Carmichael contact or Neil Steven, Director, on 0131 220 2203 or email neil.steven@jcca.co.uk.