Take advantage of the Annual Investment Allowance

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The annual investment allowance (AIA) allows businesses to obtain an immediate deduction against profits for capital expenditure up to the limit of the allowance.

Where a business prepares accounts using the more traditional accruals basis, they are not allowed to deduct capital expenditure in computing profits; instead relief for capital expenditure is given under the capital allowances system, whether in the form of the AIA, a first-year allowance or a writing down allowance.

Where a business prepares accounts using the cash basis, different rules apply to capital expenditure.  Under the cash basis, capital expenditure can be deducted in computing profits unless the expenditure is of a type where such as deduction is prohibited, for example, as is the case for land and cars. Capital allowances are not in point (except for cars), and the annual investment allowance is not available.

What expenditure qualified for the AIA?

The AIA is available on most items of plant and machinery, the main exception being cars. The AIA is likewise not available on items owned for another reason before they were used in the business or on items given to the proprietor or the business.

The AIA can only be claimed for the period in which the item of plant or machinery was purchased. If the payment is due within four months, the date of purchase is when the contract is signed. Where payment is due more than four months later, the date is that of when the payment is due.

The claim is made in the company or self-assessment tax return, as appropriate.

How much is the AIA?

The allowance is set at £200,000 for 12-month periods. The allowance is reduced proportionately for accounting periods of less than 12 months (so, if the accounting period is nine months, the AIA limit for that period is £150,000 (9/12 x £200,000)).

If qualifying expenditure in the period is less than the AIA for that period, the AIA can be claimed for the full amount of the expenditure. However, if qualifying capital expenditure in the period is more than the AIA for that period, the AIA can only be claimed up to the amount of the allowance, with relief for the balance of the expenditure being given by means of writing down allowances.

Example 1

Harry buys three vans costing £20,000 each in the year to 30 September 2018. The total expenditure of £60,000 is less than the AIA available for the period, so he is able to claim the AIA for the full amount of the expenditure.

Example 2

George buys new machinery costing £300,000 in the year to 31 October 2018. The expenditure exceeds the available AIA for the period of £200,000. He is able to claim the AIA on the first £200,000 of the expenditure. Relief for the remaining £100,000 is given by way of writing down allowances.

How is relief given?

Relief is given as a deduction in computing profits for the period. Thus, claiming the AIA provides immediate 100% relief for capital expenditure.

What happens when the item is sold?

If the item is sold, the proceeds are added to the relevant pool. This may trigger a balancing charge.

Do we have to claim the AIA?

No – a claim is not mandatory. It will not always be beneficial to claim the AIA, for example if profits are insufficient or the item is likely to be sold after a short period triggering a balancing charge; it may be preferable to claim writing down allowances instead. The claim can be tailored to the business’ circumstances.

Pre-Trading Expenditure

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Claim a deduction for pre-trading expenses

As a general rule, a deduction is allowed for expenses that are incurred wholly and exclusively for the purpose of the trade. Thus, for the deduction to be available, the business must have started trading. However, most businesses will incur expenses in setting up the business. These may include rents and other premises costs, marketing and advertising costs, the purchase of office supplies and stationery, and such like. These costs will be incurred before the business starts to trade rather than when the business is trading; they are incurred to put the business in position to trade, rather than for the purposes of the trade.

Luckily, help is at hand and the tax legislation specifically allows relief for pre-trading expenses, as long as certain conditions are met. Relief is available for both income tax and corporation tax purposes, providing a deduction regardless of whether the trader operates as a sole trader or via a limited company.

The relief is available for:

  • expenditure which is incurred within a period of seven years prior to the commencement of the trade, profession or vocation; and
  • which is not allowable as a deduction, but which would have been allowable had the expenditure been incurred after the trade had commenced.

Applying the ‘wholly and exclusively’ rule

The ‘wholly and exclusively’ rule applies equally to determine whether expenses which are incurred prior to the commencement of trade are deductible under the pre-trading expenses rule, as it does to determine the deductibility of expenses incurred while trading. Only those pre-trading expenses which are incurred wholly and exclusively for the purposes of the trade can be deducted under the pre-trading expenses rules.

How is relief given?

Relief is given by treating the qualifying expenses incurred in the seven years prior to the commencement of the trade as if they were incurred on the first day of trading. Consequently, they are deductible in computing the profits of the first accounting period.

Trap

The purchase of trading stock is not deductible as a pre-trading expense; it is deductible in computing profits once the trade as commenced.

Capital v revenue

Where the accruals basis is used, relief is only given for pre-trading expenses if they are revenue in nature, as is the case where the expenses are incurred once the trade as commenced. If the trader has opted to use the cash basis, capital expenses may also be deducted where these would be deductible under the cash basis rules.

Example

Dave starts trading as sports therapist on 1 November 2018. He spends six months setting up the business, acquiring premises and preparing to trade. He incurs £2,000 on rent, and £800 on marketing the business. The expenses are treated as incurred on 1 November 2018 and are deducted in computing the profits of his first accounting period.