The Chancellor’s Budget Day announcement of a new capital allowance which will allow companies to reduce their taxable profits by 130 percent of the cost of new equipment has attracted a lot of interest. But it’s also raised a number of questions, says Will Silsby, a technical officer with the Association of Taxation Technicians.
The Super Deduction defined
Very simply, the Super Deduction is a new temporary allowance which gives a greater and faster level of tax relief on qualifying expenditure incurred between April 1, 2021 and March 31, 2023. For most expenditure on plant and machinery, Silsby says that it works by treating the company as if it had spent an extra 30 per cent on the item and then allowing tax relief on the whole of that uplifted amount in calculating the tax bill for the year of expenditure.
He says: “So with a 19 per cent tax rate, the Super Deduction is designed to reduce a company’s tax bill by some 24.7 per cent of the actual cost of the qualifying item(s).” But the allowance isn’t available to all businesses; instead, it will only be available to those that are subject to Corporation Tax — typically, limited companies. This means that sole traders and partnerships will not be able to claim it and nor will it be available to a company if it is ceasing activity.
Only certain expenditure qualifies
The Super Deduction only applies to items which are treated for tax purposes as plant and machinery. For many businesses, Silsby says that “this is likely to cover most of their expenditure and simple examples of plant and machinery would include anything from a laptop to a double-decker bus. In contrast, a building or structure, or something intangible such as a franchise, cannot be plant or machinery and will not be eligible for the Super Deduction.”
He also makes clear that a special provision in the legislation means that “any expenditure incurred as a result of a contract which was entered before March 3, 2021 will be ineligible as the expenditure is treated as made before April 1, 2021 regardless of when payment was required.” It should also be pointed out that some items of plant or machinery are specifically excluded from eligibility. Common examples include cars; used and second-hand assets; and plant or machinery which is leased out to another.
The practical effect of the Super Deduction
Before delving into the effects of the Super Deduction, Silsby notes that all businesses (whether limited companies, partnerships, or sole traders) are already entitled to an Annual Investment Allowance (AIA) which enables them to get tax relief on the whole of their qualifying expenditure for the year of purchase, up to an annual limit. “Until December 31, 2021,” he says, “the AIA limit is 1 million, but is scheduled to reduce to 200,000 from January 1 2022.”
He explains: “The higher limit means that a company spending 500,000 before April 1, 2021 on plant or machinery will (without the Super Deduction) get a tax reduction at 19 percent on that amount, so 95,000. If that same level of expenditure was incurred after March 31, 2021 and qualified for the Super Deduction, the tax reduction would instead be 500,000 x 130 percent which, at 19 percent, gives a tax reduction of 123,500 — so 28,500 more.” An interesting effect of the Super Deduction is that at higher levels of qualifying expenditure it creates a disproportionately greater benefit.
A separate Special Rate allowance
As already noted, some items of plant and machinery are not eligible for the Super Deduction. This includes all items of capital expenditure which are treated as ‘special rate’ assets. Silsby details that these assets include integral features of a building (items like heating, lighting, and power systems, air conditioning, and escalators), long life assets (with an expected useful life of at least 25 years), thermal insulation, and solar panels.
Silsby says: “Under the general capital allowance legislation, the annual Writing Down Allowance on these items of plant or machinery is just six percent rather than the normal 18 percent meaning that these ‘special rate’ assets are written off more slowly for tax purposes.” But there’s a catch, says Silsby: “If a company incurs qualifying expenditure on these types of asset in the two-year period starting on April 1, 2021, they cannot qualify for the 30% value boost explained above.”
However, he says that companies in this situation will be, provided that the particular assets are not specifically disqualified, entitled to new Special Rate Allowance. He says: “This provides tax relief for the year of expenditure on 50 percent of the actual cost instead of just six percent. Unlike the Super Deduction, this does not increase the value of tax relief over the life of the asset but it does significantly accelerate the relief.”
So, if, for example, the company spends 400,000 on such assets in a year, it would (ignoring the availability of any AIA) normally take over 22 years to get tax relief on 75 percent of the cost according to Silsby’s calculations. But by allowing half of the cost to be written off in the year of expenditure, the Special Rate Allowance provides tax relief on 75 percent of the cost in 11 years.
Super Deduction, the Special Rate Allowance and tax losses
Another feature of the capital allowances regimes is that they can reduce a company’s taxable profits and can therefore, says Silsby, either create or increase a loss for tax purposes. He notes: “Companies can normally carry back losses from one accounting period to the previous accounting period so that the profits of that previous period are reduced. This enables a repayment of Corporation Tax for the previous period. But because of the pandemic, the Chancellor has announced that losses arising in a company’s accounting period which ended between April 1, 2020 and March 31, 2022 can be carried back for two further years.”
Such a loss carry-back could, states Silsby, enable a company that had depressed profits to still receive early tax relief. He comments, though, that “it is important to consider the alternative of carrying the loss forward, particularly if that might result in tax relief at 25 percent instead of 19 percent.”
Lastly, it shouldn’t be forgotten that an important consequence of both the 130 percent Super Deduction and the Special Rate Allowance is that part of the tax reduction will be clawed back if the relevant asset is subsequently sold. “This,” advises Silsby, “needs to be borne in mind if such a disposal is likely.” With the complexities set down, it’s not hard to see that it is essential for any company to take appropriate professional advice in advance to ensure that the Super Deduction or the Special Rate Allowance works as expected.