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Capital allowances are the amounts allowed to be written off as expenses when you incur long-term capital expenditure. You cannot write off the entire cost of long-term assets (that will be used over a number of years) as an expense in the year the expenditure was incurred. The general idea behind capital allowances is that the cost should be expensed over the period the asset is used.

The Capital Allowances Act 2001 is the current legislation for capital allowances. This Act regulates capital allowances for the following types of expenditure:

• Plant & Machinery Allowances: The expenditure must be “qualifying expenditure” incurred for the purposes of a “qualifying activity” such as trade, business or profession. The types of expenses that fall under this category is extremely varied and have been sought to be listed in the Act.
• Industrial Buildings Allowances: Buildings include (i) Walls, floors, ceilings, doors, gates, shutters, windows and stairs, (ii) Mains services, and systems, for water, electricity and gas, (iii) Waste disposal systems (iv) Sewerage and drainage systems, (v) Shafts or other structures in which lifts, hoists, escalators and moving walkways are installed and (vi) Fire safety systems.
• Agricultural Buildings Allowances: Agricultural buildings include farmhouses, cottages, fences and such agriculture-related constructions.
• Flat Conversion Allowances: This has been defined as “qualifying expenditure” incurred in respect of a flat, i.e. a separate set of premises forming part of a building and divided horizontally from another part of the building.
• Mineral Extraction Allowances: Mineral extraction “consists of, or includes, the working of a source of mineral deposits.”
• Research & Development Allowances: Qualifying expenditure on research and development under the meaning given by section 837A of ICTA.
• Know-how Allowances: Qualifying expenditure on the acquisition of know-how, i.e. industrial information or techniques to assist in manufacture, processing, mineral extraction, agriculture, forestry and fishing.
• Patent Allowances: Qualifying expenditure on the purchase of patent rights.
• Dredging Allowances: Dredging generally means removal of anything forming part of, or projecting from the bed of the sea or any inland water for maintenance or improvement of the navigation of a harbour, estuary or waterway.

Assured Tenancy Allowances: Qualifying expenditure incurred on a building which is or includes a dwelling house let on tenancy.

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Businesses are able to claim capital allowances when they enter into a long funding lease for their buildings and machinery.

However, some firms are attempting to claim back twice their entitled tax relief by entering into, “contrived, circular transactions involving the sale, leaseback and reacquisition of their plant and machinery” over a period of a few weeks.

In a written statement to MPs, Treasury Exchequer Secretary David Gauke said: Legislation, which will have effect from today (Wednesday 9^th March), will be introduced in Finance Bill 2011 to confirm that lessees engaging in transactions of this type are only entitled to tax relief up to the actual amount of their expenditure on plant or machinery.”

He also explained that this legislation would be forcibly enforced so as to “protect future losses to the Exchequer”.

However, whilst some firms are over-claiming on their capital allowances, a whole host of others are completely unaware that they are entitled to claim anything. Consequently, they may be missing out on large sums of money.

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The Finance and Leasing Association (FLA) is calling on the Treasury to extend tax relief on energy efficient equipment to the asset finance sector.

The association believes that the extension would benefit small businesses and is calling specifically for the relaxation of the Enhanced Capital Allowances (ECAs) to cover energy saving equipment hire.

ECAs enable a business to claim up to 100 per cent first-year capital allowances on their spending on qualifying plant and machinery. Currently the ECAs apply to businesses that purchase equipment with a bank loan but not when that equipment is leased.

The FLA claims that if the ECA system was extended to include leasing companies, it would support investment in energy efficient companies by small businesses, because the benefits would be passed on through better commercial leasing rates.

A spokesperson for the FLA told Greenwise: “It would give the asset finance companies the scope to pass on the ECA through decreased rentals.”

It is hoped that, as well as offering small businesses increased support, the FLAs latest bid to the Treasury may highlight the many other benefits that can be gained through ECAs.

This article was written by Katie-Jill Rowland

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• First Year Allowances (FYA) on Plant & Machinery

  Until April 2008, small and medium enterprises were eligible to a first year allowance (FYA) of 40 or 50 percent on plant and machinery.

   

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Up to late 19^th century (1878 to be precise) there were no capital allowances.

In 1878, a “wear and tear” allowance was introduced for traders in plant and machinery by allowing them to reduce their income by the allowance amount. For mills and factories, a “mills and factories” allowance was available. The quantum of the allowance was an amount considered “just and reasonable” and tended to represent the “economic” depreciation in the value of the equipment.

A new system of allowances was introduced in 1945 to replace the above allowances. The wear & tear allowance was replaced with:

• An initial allowance of 20% on plant & machinery for the first year
• Annual writing-down allowances to represent the usage of the asset over the years; the rate was fixed by Inland Revenue and was generally 25% for plant & machinery
• A balancing adjustment when the asset was retired or sold to ensure that the total relief was equal to the actual reduction in value over the period of ownership

The mill & factories allowance was replaced by:

• An initial allowance of 10% on new buildings
• Annual writing-down allowances at 2%
• A balancing adjustment when the asset was retired or sold to make total relief equal to actual reduction in value

The building allowance was confined to industrial buildings, and shops, offices and even hotels were excluded.

An investment allowance, over and above the allowances above, was introduced in 1954 to encourage investment in industrial assets including buildings.

The system was simplified in a major way in 1971 to eliminate burdensome record-keeping and computational requirements. A further simplification in 1984 saw the elimination of initial and first year allowances, among others.

There were other changes reintroducing and withdrawing different allowances in pursuit of specific policies until capital allowances were consolidated in 1990. There was a further revision and the current legislation is CAA2001.

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