How to take advantage of the increased Annual Investment Allowance and avoid its pitfalls?

Now is a really good time to invest in your business, but you need to do it wisely!  

The Annual Investment Allowance went up from £200,000 to £1,000,000 in January this year so it might be tempting to invest now. What is more, the allowance is set to go back down to £200,00 in just two years, giving business owners limited time to take advantage of it.

But before you commit to high-value purchase, hold your horses! There are pitfalls awaiting to catch the unwary.  

First things first.

What is Annual Investment Allowance?

To claim tax relief on capital expenditure, capital allowances are available to businesses in the UK. One of them is Annual Investment Allowance which gives a significant tax-break to companies and individuals investing in their business. It allows for up to £1,000,000 of qualifying capital expenditure to be offset against taxable profits in a year of purchase resulting in an immediate tax relief rather than spreading the cost over the years as it happens when claiming Writing Down Allowances.  

What expenditure qualifies for Annual Investment Allowance?

Majority of plant and machinery used in your business qualifies for Annual Investment Allowance.

The only things on which AIA can’t be claimed are:

–        cars

–        items owned privately before being transferred to the business

–        items gifted to the business

–        land, buildings and structures (such as bridges and roads)

–        assets only used for business entertainment such as yachts.

So, what are the pitfalls of the increased allowance?

An increase in the Annual Investment Allowance sounds simple, but it actually isn’t. On January 2019 the AIA goes up to £1,000,000 and many businesses will be affected by a transitional period. Actually, only the ones with year ended 31 December will not.

If you’re wondering whether spending £1,000,000 early in 2019 is a wise idea, the answer is “probably not”.

If your year ended 31 December 2018, you’ve got it simple – you get a full £1,000,000 allowance in the year 1 Jan 2019 – 31 Dec 2019 and another £1,000,000 in the following year. Then, 1 Jan 2021 comes and you’re back to £200,000. Straightforward and simple.

However, for most businesses accounting dates will straddle 1st Jan so transitional adjustments will need to be made to work out the amount of allowance the business is entitled to – Annual Investment Allowance is affected by the financial year dates therefore, not full £1,000,000 might be available.

The rules are slightly different for accounting periods spanning 1 Jan 2019, when the new limit is introduced and for the periods straddling 1 Jan 2021.

How do the transition rules work for the first change?

Firstly, you need to work out how much AIA is available in the period.

This is done by a simple apportionment which is illustrated by the example below.

The business has its accounting year run from 1 March 2018 to 28 Feb 2019, they get

–        10 months of AIA at £200,000 (£166,666.67)

–        2 months of AIA at £1,000,000 (£166,666.67)

This is how they calculate the AIA limit:

(200,000 * 10/12) + (£1,000,000 * 2/12) = £333,333.33

Simply take the number of months in your financial year that fall into the period before AIA increase, multiply it by the limit (£200,000) and divide by 12 to work out how much allowance the business is entitled to at the old rate. Perform the same calculation, this time for the months in your financial year that fall into the increased allowance period, add the results of both calculations together and this is your AIA limit for the financial year.

But that’s not all!

There’s one more thing to be aware of – the expenditure incurred by the end of Dec 2018 is subject to £200,000 cap even if limit for the financial year is higher.

So, if the business in the example above spend £300,000 on qualifying assets in Nov 2018, it could only claim £200,000 as AIA, regardless of the fact that the total allowance for its financial year is £333,333.33. However, if the expenditure was incurred in January or February, no such restriction would apply.

What happens when the threshold comes down again?

The logic behind those apportionments seems easy to follow, however, the rules are slightly different when it comes to the second transition.

Firstly, we need to calculate the total AIA available in a given year. The rules are exactly the same as when calculating the limits for the first transition period. Have a look at the example below:

The business financial year runs from July 2020 to June 2021, they get:

–        6 months of AIA at £1,000,000 (£500,000)

–        6 months of AIA at £2000,000 (£100,000)

To calculate the limit, they perform the following workings:

(£1,000,000 * 6/12) + (£200,000 * 6/12) = £600,000.

If the company in the example above spent £800,000 on qualifying expenditure in August 2020, only £600,000 could be claimed under AIA (assuming no other capital expenditure occurred in the period). However, if the £800,000 got spent in April 2020, it would be wholly allowable.

The last thing is AIA limit for expenditure incurred after Jan 2021. This is the trickiest area – the expenditure is capped at the amount that would be available for a notional period running from 1 January to the actual year end. This is a serious restriction. For the year ended 30 June 2021, the AIA limit on expenditure incurred after 1 Jan 2021 is £100,000 (6 months at £200,000 yearly allowance). So, in spite of £600,000 AIA limit for the financial year, expenditure after Jan 2021 is capped at AIA of £100,000. And if the financial year ended on 31 Jan, the limit would be as low as 1/12 of £200,000 – £16,666.

As you can see – timing is of the essence.

To finish off, let’s have a look at implications of the increased Annual Investment Allowance over the whole period. 

The company’s financial year runs from July to June. Their Annual Investment Allowance is available as follows: 

Year 1 

1 July 2018 – 30 June 2019

6 months at the old allowance (£200,000 * 6/12 = £100,000) + 6 months at the increased rate (£1,000,000 * 6/12 = £500,000) = £600,000 total allowance, BUT only £200,000 available on expenditure incurred by December 2018.  

Year 2

1 July 2019 – 30 June 2020 

No implications here: £1,000,000 available for the whole year.

Year 3 

1 July 2020 – 30 June 2021

6 months at the increased rate (£1,000,000 * 6/12 = £500,000) and 6 months at the lower rate (£200,000 * 6/12 = £100,000)  = £600,000 total allowance BUT for the period after 1 Jan 2021 the allowance is limited to £100,000.  

This is the perfect example of a situation when free, unlimited advice from your accountant is invaluable. All of our clients enjoy it, you could too. We can help you plan your expenditure to maximise tax savings. Simply drop us an e-mail to [email protected], call us on 07399 590993 or fill out the contact form and we’ll get back to you.

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