Annual Investment Allowance Extension

The UK Government recently announced a further extension of the Annual Investment Allowance £1 million temporary cap. FPM Senior Tax Manager KellyAnne Murtagh explains what this means for businesses.

What is the Annual Investment Allowance?

The Annual Investment Allowance (AIA) is a tax relief designed to stimulate investment in UK businesses. It enables businesses, including manufacturing firms, to claim tax relief on their capital investment in certain types of plant and machinery up to a specified limit each year.

How much capital expenditure qualifies?

The AIA is usually capped at annual expenditure of £200,000, however, the UK’s 2018 autumn Budget extended the limit to £1 million on a temporary basis from 1 January 2019 to 31 December 2020. Subsequently, in November 2020, the Government announced a further extension of the temporary cap to 31 December 2021.

What capital expenditure does not qualify?

AIA cannot be claimed against certain types of capital expenditure, such as:

• purchases from related parties,
• company cars, and
• structural works.

How does the Annual Investment Allowance work?

The AIA allows businesses to offset 100% of their qualifying capital expenditure on plant and machinery against taxable profits in the year of purchase. Without AIA, relief has to be claimed over a number of years at a rate of either 18% or 6% on a reducing balance basis. So, in effect, the AIA significantly accelerates tax relief.

Why is the extension of the AIA temporary cap important?

COVID-19 created uncertainty throughout much of 2020. As businesses focused on survival and employee welfare, many were not in a position to invest in plant or machinery. Nevertheless, adjusting to the changes brought about by the pandemic, and adapting business models to stay viable and relevant, highlighted a need for capital investment in many businesses. The Annual Investment Allowance temporary £1million cap extension to 31 December 2021 will help businesses making capital investments in 2021 by allowing them to deduct the full value of qualifying capital expenditure from their profits before tax in the year of purchase.

How to use the Annual Investment Allowance in 2021

There are a number of factors to consider when deciding how to use the Annual Investment Allowance in 2021, including:

• The timing of qualifying expenditure on plant and machinery determines how quickly the Annual Investment Allowance can be claimed. Where a company’s financial year straddles two periods when different AIA limits apply (as will be the case for 2022 accounting periods) the impact will need to be taken into account when planning capital expenditure.
• Dealing with unused AIA. If there is unused AIA as you approach your year-end, it may be appropriate to accelerate capital purchases planned for the next financial year. This not only maximises the available relief but also means that you get the relief sooner. For example, if you incur capital expenditure attracting AIA relief in the last month of your financial year, this will reduce your tax liability 9 months later. However, if you delay the expenditure to the first month of the next financial year, this will reduce your tax liability in 20 months’ time. So, accelerating expenditure by a matter of days in this example would fast-track tax relief by 11 months. While you incur the capital expenditure earlier you have the benefit of the plant sooner.
• What to do if you reach your AIA limit. If you are already at your AIA limit for the year, it may make sense to delay large capital purchases until the next financial year when 100% tax relief will be available. Otherwise, you will only be able to claim relief at 18% (6% for integral features) in the current year. However, any decision to delay expenditure needs to be weighed against the affect on operations if the arrival of the plant is delayed.
• Cash available for investment. Where a company does not have cash reserves or cannot secure a loan to fund the purchase of plant or machinery the opportunity to claim will be lost as the Annual Investment Allowance can only be claimed on capital expenditure that has been incurred.

When is capital expenditure incurred?

For the purposes of claiming the Annual Investment Allowance, capital expenditure is normally considered to be incurred on the date when the obligation to pay becomes unconditional. This is usually when the asset is delivered and is in use, however, there are exceptions:

• Where a payment is due more than four months after the date when the obligation becomes unconditional, the payment is treated as incurred when it is paid;
• Where there are stage payments under a ‘milestone’ contract and the specified conditions are met, the expenditure is treated as incurred before the end of the chargeable period if the obligation to pay becomes unconditional within one month of the end of the period.

Obviously, the commercial requirements of the business should drive capital expenditure decisions. It is seldom worth spending money just to save tax. However, if you have identified a need to invest in plant or machinery, it may be worth considering whether to bring your expenditure forward or delay it a little.

AIA restrictions on groups and related businesses

Companies in a group structure are only entitled to one AIA between them. Likewise, companies/businesses under common control that are considered related can only claim one AIA (examples include businesses with similar trading activity or trading from the same premises). These businesses need to take into account the capital expenditure requirements of the wider group to ensure that the AIA delivers the maximum benefit.

Other Capital Tax Reliefs

It is worth keeping in mind that you may be able to avail of other capital allowances if you have reached your AIA limit or if your proposed capital investment does not qualify for relief under AIA. Examples include”

• Short-Life Assets—special tax treatment of assets that have a useful life of less than 8 years
• Structural Buildings Allowance—relief spread over first 33.3 years of ownership after expenditure incurred
• R&D Allowances—relief is given at 100% if incurred to progress a qualifying R&D project
• Historical Capital Allowance—relief for expenditure previously treated as ineligible (this is particularly relevant for commercial property).