Capital allowances and the importance of timing

Under UK tax law, the general rule is that capital expenditure is not deductible when computing taxable profits. However, there is a long-established system of capital allowances that provides tax relief for certain types of capital expenditure. Under this system, tax relief may be spread over a number of years, and the time taken to obtain full relief often exceeds the expected lifespan of the eligible assets.

The super-deduction

The super-deduction and related first-year ‘special rate’ allowance (SR allowance) for qualifying expenditure incurred by companies between 1 April 2021 and 31 March 2023, announced at the Spring Budget 2021, compare favourably with the normal capital allowances position: 

• with a super-deduction equal to 130 per cent of qualifying expenditure on ‘main pool’ plant and machinery incurred in an accounting period ended on or before 31 March 2023 available in that period, compared with the usual standard 18 per cent per year writing down allowance (the super-deduction will be between 100 per cent and 130 per cent of the qualifying expenditure if the accounting period straddles 31 March 2023); and
• with an initial SR allowance of 50 per cent of qualifying expenditure on ‘special rate pool’ items in an accounting period ended on or before 31 March 2023 available in that period, with the usual standard 6 per cent per year writing down allowance available thereafter on the remaining unrelieved expenditure, compared with the usual standard 6 per cent per year writing down allowance in the year of acquisition and thereafter.

The 30 per cent enhancement to the deduction for main pool items delivers a cash tax saving worth of 24.7 per cent of the expenditure in year one (based on a 19 per cent corporation tax rate). The cash flow benefit of the super-deduction and SR allowance, as opposed to standard capital allowances, based on a notional £1m of qualifying spend and assuming a corporation tax rate of 19 per cent with no available annual investment allowance (see below) which could otherwise be utilised in respect of the expenditure, can be illustrated as follows.

• £1m main pool spend would give rise to a £1.3m tax deduction and a £247,000 cash tax effect in year one where the super-deduction applies, as opposed to a £180,000 tax deduction and a £34,200 cash tax effect in year one, with further allowances in subsequent years on a reducing balance basis, where standard capital allowances rules apply; and
• £1m special rate pool spend would give rise to a £500,000 tax deduction and a £95,000 cash tax effect where the SR allowance applies, as opposed to a £60,000 tax deduction and an £11,400 cash tax effect in year one, again with further allowances in subsequent years on a reducing balance basis, where standard capital allowances rules apply.

The cash flow benefits of the current super-deduction and SR allowance incentives can be clearly seen, however there are a number of factors which can impact the availability of these reliefs.

Issues to consider

A key point to be aware of is that not all expenditure on plant and machinery will qualify for either the super-deduction or the SR allowance. For example, expenditure on assets which are purchased in order to be leased out will not generally attract these temporary reliefs. It should be noted, however, that this does not apply to landlords that install ‘background plant and machinery’ into a building that they lease out.

A further issue relates to the timing of both expenditure and procurement. Not only must the expenditure be incurred between 1 April 2021 and 31 March 2023, but the contract for the purchase of the asset must have been entered into after 3 March 2021. For planned or future expenditure on equipment, the well-publicised challenges within global supply chains means that completing purchases before 1 April 2023, so as to secure the super-deduction or SR allowance, may be difficult in some cases. For projects that are already underway, the contract may have been entered into before 3 March 2021, thereby preventing the temporary reliefs from applying, even if the date the expenditure is incurred for capital allowances purposes falls within the required window.

Where qualifying expenditure is incurred on projects involving building works, further complications may arise. For example, the availability of the super-deduction or SR allowance may be determined by whether the eligible assets are procured by the main contractor, or subject to a separate contract directly between the end user and supplier.

Other considerations

Following the introduction of the super-deduction and the SR allowance, it was also announced that the reduction in the annual investment allowance (AIA) due to take effect from 1 January 2022 would be delayed until 1 April 2023. The AIA provides a 100 per cent first year deduction for qualifying spend up to the allowance, which is currently £1m per year. From 1 April 2023, the AIA reduces to £200,000. When combined with the planned removal of the super-deduction on the same date, this will result in substantially less attractive rates of tax relief for capital expenditure.

Considering all the capital expenditure incentives together, including those non-temporary reliefs such as short life asset allowances, is key to optimising not just the overall amount of tax relief, but also the timing of when it is accessed. Taking professional advice on the eligibility and timing of capital expenditure may make a significant difference to the amount and timing of tax liabilities.

For more information, please get in touch with Rupert Guppy, or your usual RSM contact.