The way in which relief for capital expenditure is given depends on the way in which the accounts are prepared. For companies, and for sole traders and partnerships not eligible to use the cash basis, accounts must be prepared using the traditional accruals basis.
Under the accruals basis, a deduction is not permitted for capital expenditure when computing profits; instead relief is given in the form of capital allowances. By contrast, where accounts are prepared using the cash basis, capital expenditure can be deducted in computing profits unless the expenditure is of a type for which a deduction is expressly denied, as is the case for expenditure on land, buildings and cars.
AIA v WDA
There are two main types of capital allowance available for expenditure on plant and machinery – the annual investment allowance and writing down allowances. The annual investment allowance (AIA) gives an immediate deduction against profits, whereas the writing down allowance (WDA) provides a deduction over a number of years (the tax equivalent of depreciation).
Nature of the AIA
The annual investment allowance allows a business to deduct the full cost of an item when calculating taxable profits, as long as the available annual investment allowance is sufficient and the expenditure is qualifying expenditure.
It can be claimed on most items of plant and machinery, but is not available in respect of cars.
The AIA limit is set at £1 million from 1 January 2019 to 31 December 2020. It is due to revert to the normal level of £200,000 from 1 January 2021.
Where the accounting period falls wholly within the period from 1 January 2019 to 31 December 2020, the AIA limit is £1 million; where it spans either of these dates, transitional rules apply to determine the limit – check your limit for these periods with your accountant.
Nature of WDAs
Writing down allowances may be claimed where the AIA is not available, either because the limit has been used up or because the expenditure is of a type, such as that on cars, which does not qualify for the AIA. There are different rates of writing down allowance.
Items in the main rate pool attract a writing down allowance of 18%. The allowance is calculated on a reducing balance basis. Items are allocated to the main pool unless they are of a type that must be allocated to a single rate pool or they are in a single asset pool. Cars with CO2 emissions of more 130g/km or more, features integral to a building, long life assets or thermal insulation are allocated to the special rate pool, which has a lower rate of writing down allowance of 6%. Some assets, such as new cars with CO2 emissions of 50g/km or less qualify for 100% first year allowances.
AIA or WDA – which is better
Although the AIA provides immediate relief for expenditure, claiming the AIA will not always be the best option. If the trader is only planning to keep the asset for a short time, claiming the AIA now may trigger a large balancing charge on disposal – this may be something that the business wishes to avoid.
It may also be preferable to claim a writing down allowance where claiming the AIA would result in the personal allowance being wasted or create a loss.
There is no one size fits all – discuss the best option for your business with your accountant. Remember you can tailor the claim; it is not mandatory to claim the AIA on the full amount of the expenditure. However, the AIA can only be claimed in the period in which the expenditure is incurred. After that, any balance must be relieved by claiming WDAs.