Manufacturers could be worse off despite new plan and a reduction in corporation tax
RSM Tenon outlines the Capital Allowance changes and shows the impact of each
The expected unveiling of the Chancellor's Enterprise Zone Plan on Budget Day is likely to hit the headlines and overshadow the impact of the changes to the capital allowances regime.
Manufacturing companies and businesses with high capital spend could be worse off if the expected changes to capital allowances over the next 12 months go ahead as planned, warns RSM Tenon.
Although it is expected that the rate of corporation tax will be reduce to 27% (20% for small companies), the reduction in the Annual Investment Allowance (AIA) from £100K to £25K from April 2012 will mean that the majority of firms are unlikely to see any long term benefit. Small businesses could in fact see their overall tax charge rise as many rely on the AIA to provide full relief for capital expenditure. Alternatively we may see businesses significantly changing the pattern of their spend to maximise tax relief.
Manufacturers and those businesses will a high capital spend will also suffer as the increased liability arising from the reduction in capital allowances will almost certainly wipe out any benefit gained from the reduced corporation tax rate.
Andrew Hubbard, Chair of Tax at RSM Tenon, the seventh largest accountancy firm in the UK, said:
"The newly established Office of Tax Simplification has shown in its most recent report that it is not afraid to be controversial or look to the long term. We think it is only a matter of time before it tackles capital allowances. It has already been suggested that the AIA should not only be kept at current levels but it should actually increase in line with inflation. Having rejected the replacement of capital allowances with commercial depreciation the logical step would be to review the whole area of capital allowances.
"We would warmly welcome a comprehensive review so that we can move away from the tinkering we have seen over the last couple of years. With changes to the rate of capital allowances every couple of years there is a lot of confusion over what qualifies for which rates: timing of expenditure and the tax relief available will have a major impact on cash flow."
Key Changes to Capital Allowances
Annual Investment Allowance (AIA)
The AIA first made an appearance in the 2008 Budget and since then has had a bit of a roller coaster ride. In 2008/09 the allowance was £50,000, it then doubled to £100,000 for 2010/11 but from April 2012 it is expected to reduce to £25,000, although this may change following the recent OTS report.
The AIA is valuable as it allows for 100% tax relief on capital expenditure up to the relevant annual limit. It is particularly attractive to small and medium sized businesses whose annual capital expenditure is unlikely to exceed these limits and presents a considerable cash flow advantage.
Suppose a business spends £100,000 on a new machine. Under the current rules a business will get 100% relief in the current year. From April 2012, it will get 100% relief on the first £25,000 but the remaining £75,000 will be relieved on a reducing balance basis over future years. Even after 10 years only £60,000 will have been relieved.
Annual writing down allowance
Putting aside the AIA for a moment, tax relief for capital expenditure is given annually as a fixed percentage on a reducing balance basis. Once again the general trend of the fixed percentage is downwards. For many years it has been at 25% with the occasional temporary 'first year allowance' of 40% or 50% when the Government has been tempted to try and encourage investment. In 2006 the 25% reduced to 20% and from next April we will see a further reduction to 18%.
Industrial and Agricultural Buildings (IBAs and ABAs)
IBAs and ABAs have been being phased out over the last couple of years and from April 2011 they will disappear completely. Whilst these allowances were never huge (4% at their peak!) it serves to further highlight the general trend on the tax treatment of capital expenditure.
Green Expenditure
Environmentally friendly purchases have been encouraged by the Government for many years now. The capital allowances regime is no different in that respect as higher allowances are generally available for energy efficient plant and machinery and we are likely to see further changes in this area. The biggest issue here is one of awareness - all too often the capital allowance position is considered after the purchasing decision has been made. A slight change in spec could mean a big difference in available allowances.
Enterprise Zone Plan (EZ)
Under the previous EZ regime, tax relief was given at 100% on buildings and plant and machinery expenditure incurred in designated enterprise zones. One can but speculate that a similar approach will be adopted this time round and the success of the plan will surely depend upon where the designated EZ areas are and whether businesses actually want to base themselves there commercially. It will take a lot more than tax relief on capital expenditure to entice businesses into derelict areas with poor infrastructure and communication links.