Capital Allowance changes – Emergency Budget 2010 05/07/2010

Whilst the reduction in the headline rates of corporation tax in the Emergency Budget was not unexpected, it was anticipated that there would be a simplification of the existing capital allowances regime. However, the latter did not crystallise with instead a mere reduction of 2% in the rates of capital allowances allied with a reduction in the 100% Annual Investment Allowance from April 2012.

As such, the critical changes announced were less severe than had been expected:

• A reduction in the main rate of corporation tax from 28% to 24% phased in over 4 years at 1% per annum from April 2011.
• A reduction in the small companies’ rate of corporation tax from 21% to 20% from April 2011.
• The rate of writing down allowance (WDA) falling from 20% to 18% from April 2012 for plant and machinery.
• The rate of WDA for the special rate pool (encompassing integral features, thermal insulation and long life assets) falling from 10% to 8% from April 2012.
• A cut in the Annual Investment Allowance (AIA) from £100,000 to £25,000 from April 2012.

One crucial aspect of the above capital allowance changes is that they will apply to all businesses including companies, partnerships and sole traders. However, the reduction in the corporation tax rates will only affect companies thus putting unincorporated entities at something of a cash flow disadvantage in terms of being unable to reduce their tax bills commensurately.

Clearly, the reduction in the AIA will be a major blow for SMEs and not merely in the forms of cash flow as the relief was originally introduced with the intention of making the claiming of reliefs simpler. Such businesses will now have to complete a detailed review of any expenditure over and above £25,000, with an eye on all the various capital allowance categories, to ensure they correctly identify the tax relief to which they are entitled.

Larger businesses outwith the capital-intensive industries will fare best from the changes, benefiting from the corporate tax rate reductions without being overly concerned about the capital allowance rate reductions. The clear losers are individuals and partnerships who will only feel the negative impact of the changes to the capital allowances regime.

Overall, whilst the changes are not as bad as was feared, the changes have simply maintained a complex system of reliefs but with lower tax savings. However, whilst full capital allowances will be recovered in the long term, the changes will result in a timing issue for obtaining tax relief rather than a removal of allowances, affecting cashflow in the short term. Minimisation actions that businesses should be considering therefore include:

• Accelerating capital expenditure before the drop in the rates of capital allowances.
• For businesses currently loss-making but anticipating future profitability, instead of disclaiming allowances it may be worth claiming now to take advantage of the current higher rates of capital allowances before the reductions take effect.
• Ensuring expenditure on energy and environmentally efficient plant is correctly identified and 100% capital allowances claimed accordingly.
• For any open returns, recategorise expenditure previously treated as industrial buildings as plant and machinery , as per HMRC guidance Brief 12/09.