Now that the 2020/21 tax year has come to an end, there are a variety of tax filing obligations on employers. One of these obligations is…
*13 November 2020 – Government has announced a further extension to the £1m allowance until 1 January 2022 – it was due to revert to £200,000 on 1 January 2021.
Businesses often need to make capital investments in order to improve efficiencies, expand or simply keep up with the latest technology.
When the level of the Annual Investment Allowance (AIA) was first introduced in 2008 it was to encourage investment and allowed businesses to write off 100% of the cost of qualifying assets against their taxable profits, up to a certain limit.
This limit started at £50,000 and has been as high as £1m since 1 January 2019. This £1m temporary increase to encourage investment is due to come to an end on 31 December 2020 where it will revert to the current ‘permanent’ rate of £200,000, which is a significant reduction.
Many businesses may not spend close to £1m, or even £200,000. However, these limits are pro-rated across a financial year and so the accelerated tax relief business owners get with an AIA limit of £200,000 can actually become a much smaller figure depending on when your spend takes place. Let me go through an example below.
You have a 31 March year end and every year around January you may consider the financial performance for the year and what capital purchases are necessary for your business. Any purchases made before the year end, assuming they meet all the qualifying criteria for AIA, are then deducted from your taxable profits.
So, if £250,000 of machinery was purchased in March 2020, this would have been deducted in full from your taxable profits. However, if this spend is replicated in March 2021 you will only be able to deduct £50,000 (see below) in full from your taxable profits and the rest at a reduced rate.
April 2020 to December 2020: AIA limit £1m x 9 months = £750,000
January 2021 to March 2021: AIA limit £200,000 x 3 months = £50,000
The key point here is the timing of your capital expenditure. If you usually look to spend towards the end of the tax year (i.e. in the last few months) then you can only spend a maximum of £50,000 on capital and get 100% tax relief. Any expenditure above this in the period will have a slower rate of tax relief. The important message is do not leave all your capital expenditure until early 2021.
As always we would never advise to invest in capital equipment just to reduce tax but if the expenditure is required for the good of the business then try and ensure that the asset is delivered and working in your business by Christmas, to maximise the tax benefit.
Keep an eye out for any announcements from the Government on AIA limits and if you have any questions regarding capital expenditure please do not hesitate to contact me or your local PKF Francis Clark adviser.