At the end of 2020 the annual investment allowance (AIA) reverts to £200,000. If your financial year spans the change, transitional rules can unexpectedly restrict your entitlement further. Why, and what steps can you take to work around this?
Annual investment allowance
The annual investment allowance (AIA) is a capital allowance (CA) which gives you a tax deduction for 100% of qualifying expenditure, e.g. purchase of equipment, incurred in the accounting period. With a few exceptions the AIA is allowed for the cost of all equipment which would qualify for CAs.
The rise and fall of the AIA
The maximum amount of expenditure which can qualify for the AIA is usually £200,000, but this was temporarily increased to £1 million from 1 January 2019 until 31 December 2020. There are transitional rules to work out the AIA for an accounting period which spans one of the change dates, i.e. 1 January 2019 or 31 December 2020. The 2019 transitional calculations worked, and they are similar for 2020 but with one important and potentially troublesome difference.
December 2020 transition
The formula for working out the AIA for any accounting period which spans 31 December 2020 is (a/12 x £1,000,000) + (b/12 x £200,000), where “a” is the number of months in the accounting period falling on or before 31 December 2020, and b is the number of months after 31 December. The trouble is that unlike the calculation for 2019, the maximum amount of expenditure which can qualify for the AIA is capped to the proportion of the AIA limit applicable to each part of the accounting period.
Example. Acom Ltd’s next accounting year runs from 1 April 2020 to 31 March 2021. It has planned to renew some equipment over the twelve months. As it expects to spend around £180,000 the directors assume there will be no problem in claiming the AIA for all of it because it’s less than the temporary limit of £1 million and the normal limit of £200,000. But the transitional rules could prevent this.
Trap. The AIA for expenditure in the period 1 January to 31 March 2021 is capped proportionate to the normal amount, i.e. 3/12 x £200,000, which is £50,000.
If Acom were to incur all the £180,000 of expenditure on equipment in the period between January and 31 March 2021 it would only be entitled to the AIA on £50,000. The balance would qualify at the normal CAs rates of 6% or 18% per year on a reducing balance. This means it would take a minimum of twelve years to obtain even 90% of the tax relief it’s entitled to.
Tip 1. To avoid the trap and obtain the AIA for all its expenditure Acom should incur at least £130,000 (£180,000 – £50,000) of it on or before 31 December 2020.
Tip 2. Bear in mind that the date on which capital expenditure is treated as incurred is the date that you commit to the purchase, i.e. usually the date you sign a purchase order or equivalent document.
After 1 January 2021 the maximum AIA is a fraction of the normal annual amount, e.g. if your financial year ends on 31 March 2021 it’s just £50,000 (£200,000 x 3/12). If you’re considering capital expenditure in excess of the restricted AIA, aim to spend on or before 31 December 2020 when the maximum AIA is much greater.
The next step
Detailed commentary on the AIA