Thanks a million! The AIA limit is up but..

 

The AIA limit is up – but beware the timing pitfalls

On the face of it, the increase in the annual investment allowance (AIA) from £200,000 to £1 million seems straightforward. You would be forgiven for thinking that major capital expenditure should perhaps be incurred early in 2019 to take early advantage of the uplift. In some cases, that will work well; in others, it will be the worst possible timing. It’s all down to some rather complex transitional rules.

The basics

As a reminder, AIAs are a way of speeding up tax relief for most qualifying expenditure on plant and machinery, including integral features (such as electrical systems) and general fixtures (such as baths, showers, toilets). There is an annual limit on the amount of expenditure that can qualify, and certain associated businesses have to share that annual limit.

The headline announcement in the Budget was that the annual cap on claiming AIAs was going up from January 2019, for a fixed two-year period.

So if a standalone company has a 31 December year end, the position is straightforward. For expenditure incurred in 2018, it can claim AIAs of up to £200,000. For expenditure in each of the following two years, that limit increases to £1 million. Thereafter (unless the goalposts are moved once more), the limit drops back down to £200,000. So far, so easy.

Where it gets harder

The difficulty is for the majority of businesses that do not have 31 December year ends, and which therefore draw accounts up for periods that span the date of change. Transitional rules kick in for periods spanning 1 January 2019, with more complex rules for periods spanning 1 January 2021. The results can be surprising and the timing of expenditure during these periods can be critical.

How does it work for the first change?

Most businesses will now be in the first transitional period (or “first straddling period” as it is termed in the legislation). These businesses need to make two calculations to determine their entitlement to AIAs.

The first calculation is to work out the maximum AIA for the whole of the period, and this is done with a simple apportionment.

Example 1

Propertyco Ltd has a portfolio of office properties on which it receives rental income. It draws its accounts up to 30 April each year and is planning some major improvement works during 2019.

The maximum AIA for the period to 30 April 2019 is calculated by working out eight months at the old rate (£200,000 x 8/12) and adding four months at the new rate (£1,000,000 x 4/12). The maximum AIA it can claim for the entire period is therefore £466,667.

So if the company has no capital expenditure in 2018 at all, has qualifying expenditure of £750,000 in January 2019, and has no further expenditure thereafter, its AIA is capped at £466,667 (even though all of the expenditure was incurred after the limit was increased to £1 million).

A second restriction also applies, which is that expenditure incurred before the end of December 2018 is capped at the old figure, even though it falls into a year that continues after that date.

Example 2

Suppose that the company incurred all the expenditure a month earlier, in December 2018. In this case, the AIA would be restricted to £200,000, so the timing makes a big difference.

What happens when the threshold comes down again?

The logic of the way these allowances work is reasonably clear to follow. But the rules that will apply in two years from now, when the threshold drops back down again, is less intuitive. Again, a two-part calculation is needed.

Once more, the first step is to calculate the maximum AIA that can be given for the whole period, and this is again done by taking so many months at the older rate and so many at the newer one.

Example 3

A company draws accounts up for the year to 31 March 2021. That period includes nine months for which the maximum was £1,000,000, and three months for which it is £200,000. So we add (£1,000,000 x 9/12) to (£200,000 x 3/12) and this gives us a result of £800,000.

This figure is the maximum AIA that can be claimed for the year in question.

Retrospective effect!

Note that the decrease in the rate from 1 January 2021 will therefore affect the amount of AIAs that can be claimed for expenditure in 2020, when (in theory) the maximum amount is still available.

So suppose that the company in Example 3 above spent £1.2million on assets qualifying for capital allowances in the period from (say) July to December 2020. The instinctive view is that it can claim AIA of £1 million. In reality, the AIA is capped at £800,000.

This gets more extreme for later accounting periods. So, for example, a company drawing accounts up to 30 September 2021 will have its AIA capped at £400,000, even if that expenditure is incurred in the last three months of 2020.

And there is still one more calculation to be done! This restricts the amount of AIA that can be claimed for accounting periods straddling 1 January 2021, where the expenditure is incurred on or after that date. For this expenditure, AIA is capped at the amount that would be available for a notional period running from 1 January to the actual year end. As this will be a shorter period than 12 months, allowances are restricted accordingly. And this is where the results can be most extreme

Example 4

Another company draws accounts up to 31 January 2021. It has to incur a large, one-off expense on which it wishes to claim AIAs.

If it incurs the expenditure in December 2020, it can claim AIAs on up to £933,333. If it waits until February 2021, the cap will be just £200,000. But the real shock is if it spends the money in January 2021. In this case, the AIA will be capped at just £16,667 (calculated as one month’s worth of allowance at the new annual amount of £200,000).

Help!
Clients who may be incurring expenditure over the coming two to three years need to be aware of these wildly fluctuating amounts. We can work with you to provide any details that are needed for particular combinations of dates. Or we can help you draft a bulletin if you would like to keep your clients informed.

To simplify the examples in this blog post, we have restricted the examples to companies paying corporation tax, but the same principles apply for sole traders and partnerships, albeit with some minor tweaking of the figures. Again, let us know if we can help.