Many businesses have claimed the 100 per cent annual investment allowance in respect of plant and machinery purchases in the last four years.
While this allowance has been very useful in cash-flow terms, ensuring that all available tax relief was given at the earliest possible opportunity, what is often overlooked is the effect this could have on taxable profit levels going forward.
While most businesses write off the cost of assets in their accounts by applying depreciation at a rate of between 15 per cent and 25 per cent a year, this depreciation is not allowable for tax purposes. To ensure that a standard rate applies to all businesses, the depreciation charge is replaced by capital allowances that are calculated at varying rates set by the government. Where the rates of capital allowances and depreciation are similar, this means that the accounting profit and the taxable profit are broadly similar, subject to any other adjustments required for non-allowable expenditure. Where the 100 per cent annual investment allowance has been claimed, however, the entire cost of new assets would be claimed as a tax deduction at the time of acquisition and there is no tax value being carried forward from year to year, on which an annual writing-down allowance can be claimed.
The depreciation charge will be applied each year in the accounts, however, and it will have to be added back on to the profit in the tax computation. The situation is compounded if assets on which full tax relief has been claimed previously are sold or traded in.
This means that the taxable profit is likely to be higher than the accounting profit for a few years until the value of the assets in the accounts are written down significantly.
Tax liabilities may well be calculated on profits higher than those shown in the business accounts.
In future years, this difference between the capital allowances and the depreciation is likely to be less marked as the maximum amount of expenditure eligible for the annual investment allowance is being reduced to £25,000 a year from the beginning of April 2012. Subject to trading conditions, this should lead to less fluctuation in taxable profit levels and therefore tax liabilities.
Business types with traditionally high levels of expenditure on equipment or commercial vehicles, for example farmers, contractors or hauliers, are most likely to be affected. We would, however, encourage all business with any significant level of historic expenditure of this nature to look at their situation and obtain advice as to the extent of the problem, when the tax liabilities are likely to arise and action that may be taken to mitigate these.
We hope that you will find these comments helpful but if you would like to discuss the matter in more detail, or consider the circumstances of your business, Mark Thompson can be contacted on (01573) 224391, email mark.thompson@renniewelch.co.uk