One of the surprises in the 2012 Autumn Statement was a temporary tenfold increase - to £250,000 - in the Annual Investment Allowance (AIA) for capital expenditure on plant and machinery between 1 January 2013 and 1 January 2015. The benefit of an AIA is that it provides 100% tax relief in the accounting period in which the expenditure is actually incurred.
To secure the maximum available tax benefit, a carefully planned purchase programme must take due regard of the business’s financial year end.
Get the timing and/or the amounts wrong, and the business could either miss out on available tax relief or end up paying far more tax than required.
A business with the same accounting period as the tax year would normally be easy to calculate, but the January introduction of the AIA creates a straddling period which results in only three twelfths of £250,000 being eligible for an AIA claim for any expenditure in the first calendar quarter of 2013. If there is no expenditure in that first quarter then up to £62,500 of potential tax write off will be lost in that accounting year.
However, a business with a financial year ending 31 December, could spend £250,000 at any time from 1 January until the end of December 2013. If it makes at least £250,000 of profits during 2013, it will be able to write off the whole amount. For other accounting periods the scenarios are more complex, but even for these businesses there is a middle period which does not straddle the January 2013 introduction date or the January 2015 end date where the full £250,000 AIA can be claimed.
To secure the maximum tax benefit, a carefully planned purchase must take due regard of a business’ financial year end
Imagine a partnership that has made good profits and is contemplating replacing some machinery, having not purchased any that year. The approach of the 2013/14 tax year end is causing their accountant some concern, with the potential of a big income tax bill. Even after claiming all available expenses, a profit of £250,000 remains, which would attract the 40% income tax rate. The partnership’s accounting period matches the tax year.
The accountant explains that, if the partnership invests £250,000 in eligible machinery, the full £250,000 AIA will apply. He also suggests that there is a great cash flow benefit to be had by using hire purchase (HP). Paying a 10% deposit (£25,000) and borrowing £225,000 over three years on a hire purchase agreement equates to a £100,000 outlay in the first year of the acquisition, followed by £75,000 in each of the subsequent years (net of interest charges).
The £100,000 expenditure over the first year equals the £100,000 tax bill saved, so HM Revenue & Customs has effectively paid for the partnership’s deposit and its first year’s HP payments.
Not only that, but the partnership has managed its cash flow in an exemplary fashion - claiming the maximum £250,000 AIA but with an outlay of perhaps only £25,000.
However, the firm has an accounting period that straddles the 1 January 2013, so a phased purchasing plan will be required to maximise the AIA that can be claimed. If £62,500 is not spent in the first quarter of 2013 then that AIA will be lost forever.
Equally, only £187,500 AIA is available between April and December 2014 because the AIA will drop to £25,000 from 1 January 2015 onwards.
Only three twelfths of the subsequent £25,000 AIA (£6,250) can be claimed in that last quarter, so don’t leave it until the last quarter to make the purchase.
- Nigel Greenaway is general manager - marketing at JCB Finance.