The expenditure which any business incurs on buying new capital equipment such as ‘plant or machinery’, cannot normally be deducted from profits as a business expense in the same way that, for example, staff salaries or travel costs are deducted.
Instead, expenditure on equipment and the like which is expected to have lasting use in the business, qualifies for special allowances known as ‘capital allowances’. The amount of these allowances is deducted as a separate item in the tax computation for the business, after the net profits for the year have been arrived at.
As with nearly all tax rules, there are many complex areas of detail and what follows is a summary as a general guide. You will need to refer to us for detailed advice on any aspect before proceeding with an expectation of receiving a particular tax allowance.
Capital allowances for machinery and plant are only given to those carrying on a trade or business, which for this purpose includes a furnished holiday lettings business; separate rules apply to other types of property lettings. The allowances are available for most types of equipment and machinery used for the purposes of the business including cars, office machinery and office furniture, as well as certain systems which are built into the business premises itself, such as electrical systems, internal water systems, lifts and heating arrangements. Perhaps the type of ‘plant’ of greatest antiquity which still qualifies for allowances, are horses used in a farm business.
There is, however, a list of ‘structures’ which might be thought to qualify as plant but are excluded from relief by statute. This list includes mains electrical systems not serving particular items of equipment, mains water systems, car parks, doors, gates and shutters, including roller doors.
Examples of more unusual types of ‘plant’ which can qualify for allowances are towers for floodlighting, advertising hoardings, removable partition walls and fire alarm and sprinkler systems.
Any expenditure which does qualify for capital allowances as machinery or plant must then be within one of the following categories:
There are other areas of detail not covered in this memorandum, for example, relating to leased assets and equipment purchases covered by certain anti-avoidance rules.
The main system of capital allowances for plant and machinery operates by putting all acquisitions into a pool of expenditure and giving an allowance of 18% per annum for the balance of expenditure in the general pool of assets.
The way pooling works is that the cost of new items purchased is added to the existing balance brought forward to the current year. Then, the proceeds of any sale of items included in the pool from past years are deducted from the balance. The net result receives the 18% allowance.
This general pool will not include the items listed above which qualify for either 8% or 100% allowances, but cars used wholly for business which have CO2 emissions of more than 75g/km but not exceeding 130g/km, will go into the pool; so will include many smaller petrol-engined business cars.
The system of pooling has the effect that annual allowances are often claimed for some of the expenditure on equipment which has been sold in the past tax year. For example, if the pool contains equipment which originally cost £50,000 and in the current year that equipment is sold for £1,000, only the sale proceeds are deducted from the balance in the pool and the remaining £49,000 continues to receive allowances as part of that pool over succeeding years.
This principle applies equally to expensive business cars used for the business. If a car is purchased costing £90,000,that expenditure will qualify for 8% annual writing down allowances (assuming that the car has high CO2 emissions). If, in a later year, the car is sold for £30,000, only those sale proceeds are deducted from the pool figure and the balance continues to receive writing down allowances at 8% per annum, even though the car has been sold.
For unincorporated businesses, if an item is used partly for business and partly for private purposes, a common example being a car, it does not go into the general pool but is kept separate and calculations for that asset are made on an individual basis. They must be reduced to reflect the extent of private use. The advantage with these ‘single asset pools’ is that on disposal of the item concerned for less than the pool value brought forward, an immediate allowance based on the remaining pool value, after deduction of the sale proceeds, can be claimed for tax purposes. The pool value must be reduced in accordance with the overall proportion of business use to find the final tax allowance.
Thus, if the expensive car referred to above was bought by a sole trader, and had some private use, a final balancing allowance would be available on disposal, instead of the continuing allowances over subsequent years which apply where the asset is used wholly for business.
Most general plant and machinery can qualify for a 100% allowance in the year of purchase up to an upper limit. From 1 January 2016 onwards, the annual limit has been set at £200,000. Business cars do not qualify for this allowance and there are some other exclusions, but most ordinary equipment such as computers, copying machines, vans and goods vehicles, do qualify and this allowance therefore effectively enables the cost (up to the applicable upper limit) to be fully written off in the year of purchase.
The allowances for plant and machinery are available generally to all types of businesses but an entirely different category of expenditure is available only to companies: this category is for R&D expenditure. It can, however, be an important topic for companies to consider because the relief is quite generous and has been successively increased.
Expenditure can qualify for R&D relief if it relates to a project which seeks to achieve an advance in overall knowledge or capability in a field of science or technology. HMRC will look for some aspect of the project which resolves a particular scientific or technological problem and not simply advances existing knowledge or capability. HMRC say: ‘It is not enough that a product is commercially innovative. You cannot claim in respect of projects to develop innovative business products or services that do not incorporate any advance in science or technology’.
Accordingly, it will be appreciated that if expenditure is to qualify for the relief, it must satisfy a high standard for innovation. Once this test is satisfied, however, the relief can be claimed on specific expenditure which relates to the particular project, including staffing costs, certain expenditure on subcontractors, computer software and consumable items, as well as payments in respect of clinical trials.
For small and medium-sized companies, the new level of relief from 1 April 2015 is a deduction in the tax computation for 230% of the qualifying expenditure. Accordingly, if a company has spent £25,000 on a project which qualifies, it can claim a deduction in its tax computation for £57,500. A different rate and relief mechanism applies for large companies, or certain smaller companies carrying out R&D on another company’s behalf. We can provide further details of this as required.
A company which has no corporation tax liability, owing to incurring losses for the accounting period concerned, may instead receive a cash payment from HMRC in respect of its qualifying expenditure. The amount of payable tax credit that a company is entitled to for an accounting period is 14.5% (from April 2014) of the surrenderable loss for that period.
Accordingly, it can be well worth investigating whether expenditure on the design and development of new products might qualify for R&D relief. Whilst the tests for the relief set a very high standard, where they are satisfied, the tax relief available is very generous.
Please note that this Memorandum is not intended to give specific technical advice and it should not be construed as doing so. It is designed to alert clients to some of the issues. It is not intended to give exhaustive coverage of the topic.
Professional advice should always be sought before action is either taken or refrained from as a result of information contained herein.