What is the Annual Investment Allowance?

I am a freelance web developer working through my own limited company. I am about to purchase some expensive computer equipment for my business – I believe this will be treated as a capital asset but I am unsure of the tax treatment, I have heard of something called the Annual Investment Allowance but I am not sure if I can claim this?

 

Annual Investment Allowance Explained

 

Answer, February 2018

Capital assets

You’re correct that the expensive computer equipment you’re buying for your business will be treated as a capital asset.

The cost will be recorded in the balance sheet section of your accounts and then, each year, you’ll move part of this cost to your profit and loss account as a “depreciation” charge.

The simplest method is to estimate the number of years you’ll use the equipment in your business, and spread the cost over this number of years.

The tax treatment for your computer equipment purchase is somewhat different. In fact, for once, the taxman is generous and will allow you to deduct the full cost of your equipment from your profit in the year you make the purchase.

 

Capital allowances

The legislation that covers this is called “capital allowances” and within this, the type of capital allowance you’ll be using is called the “Annual Investment Allowance” (AIA).

The government introduced the tax relief known as the Annual Investment Allowance in 2008 – the size of the allowance has changed over the years but since 1st January 2016 it has been set at £200,000.

This is an annual allowance, so covers up to £200,000 of your relevant purchases each year.

Computer equipment for use in your business is a relevant purchase. HMRC will categorise it as “Plant and machinery”.

There are some items of plant and machinery for use in business that you can’t claim capital allowances on. These include:

  • Items you lease – you must own them
  • Buildings, including doors, gates and shutters
  • Items used only for business entertainment (HMRC includes as examples a yacht or karaoke machine!)

It’s worth mentioning that the Annual Investment Allowance cannot be claimed for company cars. These get tax relief via the part of the capital allowance system know as “writing down allowances”.

Company vans do qualify for the Annual Investment Allowance, as they are considered to be “plant and machinery” for this purpose.

There are a few other details and criteria to be able to claim the Annual Investment Allowance – for more info see HMRC guidelines here.

Once you start buying equipment, your profit recorded in your accounts will no longer be the same as the profit on which you pay corporation tax. This is because your accounts will have a depreciation charge, and your corporation tax computation will have capital allowances instead.

It sounds complicated, but should become clearer if we look at an example.

 

Annual Investment Allowance example

Let’s assume you bought computer equipment to the value of £5,000 at the start of the year and estimated that you would use it in your business for 3 years before needing to replace it. In your accounts you would include 1/3rd of the cost of the equipment as your “depreciation” expense. Your profit and loss accounts might look something like this:

 

What is the Annual Investment Allowance

 

When your corporation tax return is calculated, the depreciation expense is added back and you get your capital allowances instead.

In this example, the full £5,000 cost of the equipment you bought is allowed as part of your Annual Investment Allowance and so your taxable profit would be:

 

corporation tax profit

 

It’s important to remember, though, that this is just a way of helping with your cashflow, not an outright tax saving.

As the table below shows, your taxable profit will be increased by adding back the depreciation in years 2 and 3, without any capital allowance to deduct:

 

future years profit and loss

 

The other consideration is if you sell equipment you no longer use in your business.

When your corporation tax is worked out, you will need to include the sale proceeds for any equipment you’ve claimed capital allowances for, and you will be taxed on the profit you made.

Assuming you took advantage of the Annual Investment Allowance, the “tax written down value” of the equipment will always be £nil.

So, if after 3 years you decide to upgrade to a new computer, but manage to sell your existing equipment for £500, your tax computation will include a “balancing charge” of £500 and you will pay tax of £95 (assuming a corporation tax rate of 19%).