ICAEW.com works better with JavaScript enabled.
Exclusive

Farming & Rural Business Community

Practical points on Capital Allowances

Author: Keith Phillips, Chartered Accountant, Duncan & Toplis and Elizabeth Peters FCA CTA, Tax Partner, Ballards LLP

Published: 04 Nov 2021

Exclusive content
Access to our exclusive resources is for specific groups of subscribers.

Below are a few points arising in practice.

Issues around planning for capital allowance when working in practice

In the day-to-day world remembering points around the basics can significantly benefit the client if thought is given.

  • The answer can sometimes be do not claim full AIA
  • The drive for an asset change may be the sale of an old asset not the need for a new one
  • The need to make sure the timing of purchases gives the results expected
  • Making sure you use the pools to the best advantage
  • Consider rules as a client heads to retirement
  • Remember the interaction of special pool rules with AIA rules

Many of these points relate to all businesses but the effect on farmers who buy and sell quite expensive pieces of machinery can be quite marked.

Non incorporated cessation

The general age of farmers is considered to be very high, with statistics indicating that many farmers are well over 65, so issues around capital allowances and cessation are experienced very regularly in practice.

Indeed, sadly many work until they pass away so we get a number of sudden “retirements”. By their very nature these are difficult to plan for but, when we see famers heading to retirement, always consider the capital allowance effect.

In the final year of trading, a typical farm will ideally clear the land in September and then be selling crops over the following winter and spring and finishing this by the following 5 April, and possibly selling their farmland so under pressure to clear the barns etc. At the same time they will be selling off their machinery, either piecemeal or via a farm sale. So in the final period of trading they have not only profit on the final year cropping with few admin costs from September onward but also a very large balancing charge on the sale of the equipment that is either so old that full allowance was claimed years ago or more recent and they have claimed 100% AIA. Either way they have little or no tax pool.

Also, in the final period there is not the right to claim Farmers Averaging so often small and modest sized farmers earning £20,000 – £30,000 profit per proprietor or partner suddenly in the final year find themselves making a significant taxable profit. Much of which can end up being taxed at higher rates.

The land sale may well qualify for business asset disposal relief but there is little option on the income tax profit. Possible pension or VCT relief but neither popular with a 70-year-old retiring famer!

As a client heads into later years, do consider talking to them about their plans and consider if claiming full AIA is actually appropriate in the few years before retirement.

If this relief is not claimed it may well increase the tax charge in the years before a retirement, but this would be at 20% whereas on a subsequent sale the famer claiming at 20% tax may well be paying it back at 40%. Given machinery has been holding its value pretty well as new machinery prices rise, the effect can be quite dramatic.

The second point is to see if the client can look to be selling off equipment before his trading final year to allow any gain to be in a period when farmers averaging is still available. Remind them that the cash in the bank is better than cash in the grass!

Example

Dave the farmer who has profits of £35,000 per year buys a new tractor in 2018 for £35,000. He retires in 2022/23 when the tractor is worth £20,000. Assume personal allowance else matched other income.

Claim full AIA

2017/18 Profit  £35,000 @ 20%  Tax £7000 
2018/19
Profit
£35,000 @ 20%
 
  AIA
(£35,000)
Tax nil
2019/20
Profit £35,000 @ 20%
Tax £7000
2020/21
Profit
£35,000 @ 20%
Tax £7000
2021/22
Profit
£35,000 @ 20%
 
  Bal. Charge
£20,000 @ 40%
Tax £15,000
TOTAL Tax
    £36,000

Claim no AIA

2017/18  Profit  £35,000 @ 20% Tax £7,000
2018/19
Profit
£35,000 @ 20%
Tax £7,000

AIA
Nil  
2019/20
Profit
£35,000 @ 20%
Tax £7,000
2020/21
Profit
£35,000 @ 20%
Tax £7,000
2021/22
Profit
£35,000 @ 20%
 
  Bal. Allow.
(£15,000)
Tax £4,000
TOTAL Tax
    £32,000

Overall effect tax reduced by £4,000 and Dave has lower income in final year when pension and other income may commence.

Assets on Hire Purchase

One common issue still causing problems in practice are the anti-avoidance rules that determine when a taxpayer can claim AIA on an asset held on HP at the balance sheet date. AIA can only be claimed in the earlier period of when the asset is brought into use or is paid for.

HMRC often look at this point with farmers, especially when we see rate changes in the capital allowance regulations. Many farmers buy a combine on HP in March just before their tax year looking for relief.

If this involves HP then consideration of the anti-avoidance rules is important, as it is very difficult to justify this asset has been brought into use pre-31 March year end.

There are three points to remember though:

Firstly, in most cases when buying a combine the old one will be a trade in. So that element of the new asset has been paid for, so relief on this is possible and any true cash deposit can be also claimed. Only the balance on the HP agreement at the year-end cannot.

Secondly, if the client has a capital allowance pool then this still gives a good result as proceeds from the sale of the old combine can be offset against the pool.

It should also be remembered that the balance of any AIA can be claimed in the subsequent tax year, when the asset is brought into use.

Thirdly, the anti-avoidance rules only apply to assets on hire purchase, so if the machine is bought on the overdraft (or from credit balances), full relief can be claimed. This point should be considered if alternative sources of financing are being considered.

Changing AIA Rates

At present, a business can claim up to £1m in AIA in any individual year. This limit was planned to be reduced to £200,000 from 1/1/21, but, under the COVID-19 support mechanisms, this has been extended to purchases on or before 1/1/22, and following the Autumn statement has now been extended to 31 March 2023.

In the year of change though the limit is split into the relevant period and there is a maximum limit for each.

So, for a 31/3 year end the total will be 9/12 x £1,000,000 (£750,000) plus 3/12 x £200,000 (£50,000) so an annual total of £800,000. The point to watch though is that additions in the final three months are limited to £50,000 being the maximum allowance in that period.

Enhanced AIA

In the 2021 budget, Enhanced AIA for purchases of new equipment were introduced. This was a measure for companies only, linked to the change to a 25% tax rate from 1/4/23. The government did not wish to see companies deferring capital expenditure until that date, so gave in effect a relief very similar, as 19% x 130% is 24.7% relief.

There are rules that mean if you sell an asset acquired under the above prior to 1/4/23, you must include 130% of the proceeds so there is the challenge of individual asset pools for a period.

The other issue for medium sized farmers earning above £50,000 is that, if profits are below £250,000, the marginal rate is 26.5% rather than 25%. So on an older asset they have acquired in recent years, they received relief at 19% by claiming full AIA. If that asset is sold after 31/3/23, tax on proceeds will in effect be at 25% or even 26.5%. If sold before then, the relief clawed back will be at 19% only. This therefore tends to encourage the acquisition of new assets rather than the disposal of assets and replacement of assets already owned.

Special rate Pool

Assets that are acquired which are integral to a building and any other asset except a car that qualifies for a special rate pool, only obtains relief at 8%. As long as the total AIA limits are not exceeded then it is always best to claim the AIA on the special pool asset in preference to other assets where the WDA relief will be better than the special rate pool relief.

Other points to watch

  • Remember that the disposal value brought into the capital allowances pool is the lower of the proceeds received now (net of vat) and the original cost brought into the capital allowances pool (i.e. net of vat). Farm machinery can hold its value well and achieve high values on part exchanges so it is possible the proceeds are greater than the original cost, in which case the excess over original cost will potentially fall within the capital gains tax regime rather than income tax.
  • In some cases it may be possible to claim capital allowances on fixtures and make a s198 election agreeing values with purchaser; with the retiring farmer claiming capital allowances now if not claimed for in the past and they are eligible to claim. AIA could not be claimed but this would give a capital allowances pool that would reduce the balancing charge for the final period.
  • Where the farming business is transferred to a connected party there is the ability to make an election to transfer at tax written down value for capital allowances (remembering of course that AIA cannot be claimed in the final accounting period so you may want to have careful timing of new purchasers so these are not in the final accounting period)
  • It is possible to amend the capital allowances claim in an earlier accounting period if this is within the time for amending the self-assessment tax return i.e. before the anniversary of the 31 January filing deadline. This ties in with the suggestion of delaying the claim for capital allowances until retirement.
  • It is of course possible to restrict the claim for capital allowances where this takes total income below the personal allowance or NIC threshold – unused allowances will go into the pool where they may help the position on retirement
*The views expressed are the author's and not ICAEW's.
Category header
Topics