Capital allowances can provide valuable tax relief for businesses. However, as they need to be specifically claimed in a tax return they are often overlooked by businesses and can go to waste. Manufacturers in particular, as large investors in plant and machinery, could really benefit from maximising their claims for such allowances. So, what are they, how do they work and what can they be claimed on?
What are capital allowances?
The tax regime distinguishes between capital expenditure and revenue expenditure. Businesses are not allowed to claim a deduction for capital expenditure, such as expenditure on plant and machinery, when calculating their taxable profits or losses. The capital allowances rules alleviate this by allowing businesses to claim a deduction (known as capital allowances), in respect of qualifying expenditure, which includes expenditure on plant and machinery. The rules effectively provide a form of tax deductible depreciation in respect of the value of the plant and machinery, thereby reducing the amount of tax payable by the business.
How do capital allowances work?
Capital allowances can reduce a business' profits chargeable to corporation tax or they can increase losses to be carried backwards or forwards against profits.
Expenditure on plant and machinery that qualifies for capital allowances is pooled for accounting purposes. The essentially means that items which qualify for allowances at the same rate sit in a pool of expenditure that increases as new expenditure is incurred and reduces as allowances are claimed or plant and machinery is disposed of.
The general principle is that allowances are available to be claimed on a reducing balance basis at differing rates, but different sub-regimes have been introduced to encourage expenditure by businesses, such as the annual investment allowance and the full expensing rules, which can allow 100% of qualifying expenditure to be claimed upfront rather than spread over time.
These different sub-regimes have different rules, for example as to whether the allowances can be clawed back by HMRC on a future sale of the plant and machinery, and businesses should ensure they know how the rules work so that they can claim allowances in the most beneficial way and apply the regime which is most helpful to them.
To take an example of how allowances could work - Business A has a potential corporation tax liability of £2m. It pays corporation tax at 25%. If it was to incur £1m of expenditure on new qualifying plant and machinery then, by claiming the annual investment allowance (which is capped at £1m), it would reduce its tax liability for the year by £250,000 (being 25% of £1m) from £2m to £1.75m.
As allowances are not given automatically, if no claim is made in its tax return, Business A's tax liability would remain at £2m.
What can capital allowances be claimed on?
Capital allowances can be claimed on qualifying plant and machinery and also on the 'integral features' of a building.
Neither 'plant' nor 'machinery' are defined in the capital allowances legislation and, instead, there is extensive case law on these terms. Surprising to many, these terms do not just include industrial equipment and machinery but can include items such as wash basins and carpets.
Integral features are defined in the capital allowances legislation and include items such as electrical systems (including a lighting system), lifts, escalators and cold water systems.
Claiming capital allowances in respect of your qualifying expenditure is sensible tax planning and is accepted practice by HM Revenue & Customs.
If you have any queries concerning capital allowances and would like advice, please contact our tax specialists.
