Tolley® Exam Training BUSINESS TAX CHAPTER 10

CHAPTER 10

CAPITAL ALLOWANCES – BASIC COMPUTATIONS

In this chapter you will look at basic capital allowance computations including:
– computations in the general pool;
– additions and disposals;
– short and long accounting periods;
– when expenditure is treated as being incurred;
– pre trading expenditure;
– hire purchase agreements and leasing;
– claiming and disclaiming capital allowances.

For the purposes of the illustrations and examples in this chapter we will ignore both First
Year Allowances and the Annual Investment Allowance. These will be covered in the next
chapter.

10.1 Calculating Capital Allowances – the “General Pool”

Capital allowance “(CA)” computations are prepared for accounting periods; eg

for the year ended 31 December 2015. CAs are a trading expense for a business
and should be deducted in arriving at the trading profit figure for the accounting
period. CAA 2001, s.6

Year ended 31 December 2015

£
Adjusted profits before CAs X
Less: CAs (X)
Trading profit X

The trading profit (ie after CAs) would then be taxed in 2015/16 under CYB.

Individual CA computations are not necessary for every asset purchased. If so, this
would be a horrendous exercise for large businesses who would be required to
prepare a separate CA calculation for every piece of plant and machinery
acquired.

Instead, plant and machinery is usually “pooled” into a “general pool” (also
known as the “main pool”) and one computation is then prepared based on the
qualifying expenditure within the pool.

Plant and machinery allowances are a fixed percentage of the value of the pool,
calculated on a reducing balance basis.

The rate of CAs in the general pool is currently 18%.

Having claimed CAs within the pool at the fixed rate, the residual balance in the
pool (“the tax written down value”) is then carried forward as an opening balance
in the next accounting period where it will be written down again.

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 Illustration 1

Barney is a self-employed courier. He started trading on 1 April 2013 when he

bought a new van for £18,750. This is the only plant and machinery used in his
trade. He draws accounts annually to 31 March.

Compute the capital allowances available for the first three years of trade.

General CA claim
Pool
£ £
Year ended 31 March 2014:
Plant & machinery additions 18,750
WDA @ 18% (3,375) 3,375
Tax written down value c/fwd at 31.3.14 15,375

Year ended 31 March 2015:

Tax written down value b/fwd 15,375
WDA @ 18% (2,768) 2,768
Tax written down value c/fwd at 31.3.15 12,607

Year ended 31 March 2016:

Tax written down value b/fwd 12,607
WDA @ 18% (2,269) 2,269
Tax written down value c/fwd at 31.3.16 10,338

Barney will claim the CAs via his self-assessment returns and the amounts claimed
will be deducted from his adjusted trading profits.

10.2 General Pool – Additions and Disposals

When a trader buys additional plant and machinery for use in his trade, this
“addition” must be brought into the CA computation. Additions are brought in at
cost.

Where the cost of an asset includes VAT:

1. If the trader is VAT registered, the VAT will be recoverable from HMRC. The
addition should then be the VAT-exclusive amount.

2. If the trader is not VAT registered, he will not be able to recover the VAT from
HMRC. The addition should then be the VAT-inclusive amount as the VAT will
be a cost of acquiring the asset.

VAT registered businesses will produce accounts on a VAT-exclusive basis, so you

will rarely have to adjust for the VAT.

VAT cannot be recovered by any trader on the cost of a car which has any
private usage. Car additions should therefore be shown as the VAT inclusive
amount.

If the trader originally bought the plant and machinery for private purposes, and
then subsequently uses the plant and machinery in their business, the value on
which capital allowances can be claimed is the market value of the plant and
machinery when it starts to be used in the business rather than the original
cost. CAA 2001, s.13

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The market value is also used instead of cost where the plant and machinery is
gifted to the trader. CAA 2001, s.14

When a trader disposes of plant and machinery, the disposal must be taken out of
the CA computation. The disposal value is deducted from the general pool and
writing down allowances are calculated on the balance.

The disposal value is usually sale proceeds received. However market value will
be used as the disposal value instead of sales proceeds in each of the following
situations:

• Where the plant and machinery is sold for less than market value to someone
who cannot claim capital allowances;

• Where the plant and machinery is given away; and

• Where the trader simply stops using the plant and machinery in their business.

If the sale proceeds (or market value where relevant) is more than the original cost
of the plant and machinery, the disposal value is normally limited to the original
cost. CAA 2001, s.62

General
Pool
£
Tax written down value (WDV) brought forward X
Additions (at cost) X
Disposals (usually sale proceeds – restricted to cost) (X)
X
Allowances @ 18% (X)
Tax written down value (WDV) carried forward X

 Illustration 2

Daisy is a florist. She has traded for many years from a shop in Covent Garden. She
draws accounts annually to 31 March. The tax written down value of the general
pool at 1 April 2014 was £12,000.

Her recent capital acquisitions / (disposals) are as follows:

£
1.10.14 New computer &printer 1,900
15.10.14 Sold old computer (original cost £800) (100)
1.12.14 New front door for shop 2,000
1.5.15 New till 1,000
1.9.15 Additional shelving and racking in shop 5,000

Compute the capital allowances available for the two years ended 31 March 2016.

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General Pool CA claim

£ £
Year ended 31 March 2015:
Tax written down value b/fwd at 1.4.14 12,000
Plant and machinery additions:
– New computer and printer 1,900
13,900
Disposals:
– Old computer (100)
13,800
WDA @ 18% (2,484) 2,484
Tax written down value c/fwd at 31.3.15 11,316

Year ended 31 March 2016:

Tax written down value b/fwd at 1.4.15 11,316
Plant & machinery additions:
– New till 1,000
– Shelving and racking 5,000
17,316
WDA @ 18% (3,117) 3,117
Tax written down value c/fwd at 31.3.16 14,199

Note:

The new front door on the shop is treated as part of the building under s.21 List A,
so no plant and machinery allowances are given.

10.3 General pool – Short and Long Accounting Periods

Sometimes a trader may draw up accounts which are not for a 12-month period.

This will happen either:

a. when the individual starts trading; or

b. when the trader decides to change his accounts date.

The rate of writing down allowance of 18% applies for a 12-month accounting
period. Therefore where a trader has an accounting period which is not 12 months
long, this rate must be scaled up or down as appropriate.

 Illustration 3

Jenny started trading on 1 June 2015. Her first set of accounts covered the period
to 31 December 2015. Her only plant and machinery addition in the period was
computer equipment costing £3,600.

Compute the capital allowances available in the period to 31 December 2015.

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General Pool CA claim

£ £
7 months ended 31 December 2015:
Plant & machinery additions:
– Computer equipment 3,600
WDA @ 18% × 7/12 (378) 378
Tax written down value c/fwd at 31.12.15 3,222

 Illustration 4

Sanjay has traded for many years drawing accounts to 30 June. He decided to
change his accounts date to 31 December and did so by drawing up accounts
covering the 18-month period from 1 July 2015 to 31 December 2016.

The tax written down value of the general pool at 1 July 2015 was £150,000. On 2
August 2015, Sanjay bought new machinery costing £30,000.

Prepare the capital allowances computation for the 18 month period.

General CA claim
Pool
£ £
18 months ended 31 December 2016:
Tax written down value b/fwd at 1.7.15 150,000
Plant & machinery additions:
– Machinery 30,000
180,000
WDA @ 18% × 18/12 (48,600) 48,600
Tax written down value c/fwd at 31.12.16 131,400

10.4 When Expenditure is “Incurred”

When a trader acquires plant and machinery for use in his trade, he will receive
capital allowances in the accounting period in which the expenditure is
“incurred”. CAA 2001, s.5

The normal rule is that expenditure is “incurred” for capital allowance purposes on
the date on which the obligation to pay becomes unconditional. CAA 2001, s.5(1)

The legal obligation to pay normally arises on or within a certain time of delivery of
the plant and machinery. Therefore, in most cases expenditure is “incurred” when
the plant and machinery is delivered.

There is an exception to the general rule. If there is a gap of more than four months
between: CAA 2001, s.5(5)

a. the date on which the obligation to pay becomes unconditional; and

b. the date on which payment is required to be made;

the expenditure is not “incurred” until the date on which payment is required to be
made.

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If some of the expenditure is required to be paid more than four months after the
date on which the obligation to pay becomes unconditional and some is not, we
must split the expenditure and allocate it to separate accounting periods.

 Illustration 5

Jacob is a trader with a 31 March year-end.

He buys a new machine costing £100,000 for use in his trade. Under the terms of
the contract he has to pay £75,000 one month after delivery of the machine and
the balance of £25,000 five months after that.

He takes delivery of the machine on 21 March 2015 and his obligation to pay
becomes unconditional then.

He is legally required to pay:

• £75,000 on 21 April 2015, and

• £25,000 on 21 September 2015.

Explain the amounts that will qualify for additions for capital allowance purposes in
years ended 31 March 2015 and 2016.

The first payment is due four months or less after his obligation to pay becomes
unconditional but the second one is not. He therefore “incurs” expenditure for CA
purposes of:

1. £75,000 on 21 March 2015; and

2. £25,000 on 21 September 2015.

Therefore:

1. £75,000 is a plant and machinery addition in the year ended 31 March 2015;
and

2. £25,000 is a plant and machinery addition in the year ended 31 March 2016.

For plant and machinery which is constructed, the asset becomes the property of
the purchaser as it is being constructed. The obligation to pay for a part of an
asset that has been completed becomes unconditional when the work is certified
by an architect or engineer who has inspected the work done. Therefore for
capital allowance purposes, expenditure is incurred on the date the work is
certified.

There is an exception to this rule:

• Where the asset has become the property of the purchaser before the end of
their accounting period, and

• the work is certified within one month following the end of the accounting
period

then the expenditure on the asset is treated as incurred immediately before the
end of the accounting period. CAA 2001, s.5(4)

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 Illustration 6

A business has a year end of 31 December. On 31 August 2015 a contract was

signed for the purchase of a major item of plant costing £600,000. The construction
took place in stages over several months as follows:

Date Date of Percentage Payment due

construction certification of cost due date
completed
Stage 1 31 Oct 2015 1 Dec 2015 35% 12 Dec 2015
Stage 2 15 Dec 2015 20 Jan 2016 40% 4 Feb 2016
Stage 3 31 Jan 2016 1 Mar 2016 25% 15 Mar 2016

Explain when the expenditure is incurred for capital allowances purposes.

• £210,000 (35% × £600,000 incurred on 1 December 2015)

• £240,000 (40% × £600,000 incurred on 31 December 2015)

Therefore £450,000 of the expenditure will be given capital allowances in the year
ended 31 December 2015.

The obligation to pay the £210,000 became unconditional on the date of

certification, being 1 December 2015.

Although the obligation to pay £240,000 did not actually become unconditional
until the date of certification on 20 January 2016 (ie after the year end), as this
element of the asset had become the property of the business before the year
end and certification took place within one month after the year end, the
expenditure is deemed to be incurred on the last day of the accounting period (ie
31 December 2015).

The obligation to pay the remaining £150,000 (25% × £600,000) becomes

unconditional on 1 March 2016 and therefore will not be given capital allowances
until the year ended 31 December 2016.

10.5 Pre Trading Expenditure

If a trader acquires plant and machinery for use in his trade before trading starts,
for capital allowance purposes he is treated as incurring the expenditure on the
first day of trading. CAA 2001, s.12

For instance, if a sole trader spent £3,000 on a coffee machine for use in their cafe
on 10 April 2015, but did not open the cafe and start to trade until 1 May 2015,
then the £3,000 spent on the coffee machine would be treated as an addition for
capital allowances purposes on 1 May 2015 (ie on the first day of trade).

Remember that if the plant and machinery had originally been acquired and used
for private purposes before being used in the trade, the allowable expenditure for
capital allowance purposes is the market value when it is first used for the purposes
of the trade. CAA 2001, s.13

This expenditure is still deemed to be incurred on the date the plant and
machinery is first used for the purposes of the trade.

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10.6 Hire Purchase Agreements and Leasing

Expenditure on an asset acquired under a hire purchase (HP) contract is

“incurred” at the time when the asset is brought into use. This is despite the fact
that payment for the asset may be spread over several months or even several
years. The “4-month” rule does not apply to hire purchase agreements.
CAA 2001, s.67

Note that when an asset is acquired under a HP agreement, legal ownership of

the asset normally transfers to the purchaser on payment of the final HP instalment.
Under CAA 2001 s.67, the purchaser is treated as owning the asset at the time the
contract begins and so capital allowances are claimed from the time the asset is
brought into use.

If an initial payment for the asset is made in an accounting period before the asset
is brought into use, for example a deposit, capital allowances can be claimed on
this amount in that earlier accounting period. Capital allowances on the balance
will be claimed when the asset is brought into use.

Capital allowances are claimed on the capital cost of the asset, in other words the
cash price. The interest element is deductible from trade profits.

Contrast the rule for HP with a short leasing agreement (either an operating lease
or a finance lease) whereby a trader is hiring / borrowing an asset from someone
else. Here capital allowances are not available, as the trader does not legally own
the asset. Instead relief is given for the leasing / hiring costs via the P&L account.

However, if the lease agreement is a long funding lease agreement as described

earlier when we looked at common adjustments to profit, capital allowances are
available to the lessee. We will look at these allowances in detail in a later
chapter.

10.7 Claiming Capital Allowances

Capital allowances are not given automatically – they must be claimed within the
trader's individual self-assessment return (or corporation tax return for a company).

A claim can be made at any time until the time limit for the amendment of the
return – ie, by 31 January 2018 for a 2015/16 return.

10.8 Disclaiming Capital Allowances

There is no requirement for a trader to claim all of the capital allowances due to
him. In some instances it may be beneficial for a trader to disclaim some (or all) of
his capital allowances. This may be advantageous where a trader has low profits
which may be covered by his personal allowance for the year.

If a trader disclaims capital allowances, this will lead to a higher tax written down
value being carried forward which will, in turn, lead to higher capital allowance
claims in future years.

 Illustration 7

Paul is a self-employed window-cleaner. He draws accounts to 31 March. The tax

written down value of the general pool at 1 April 2015 was £5,000. On 21 June
2015, he bought new ladders costing £1,000.

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His tax-adjusted profits for the year ended 31 March 2016 are £5,200. He has no
other income.

Calculate Paul's trading income for 2015/16:

i. on the basis capital allowances are claimed; and

ii. on the basis capital allowances are disclaimed.

General CA claim
Pool
£ £
Year ended 31 March 2016:
Tax written down value b/fwd at 1.4.15 5,000
Plant & machinery additions:
– Ladders 1,000
6,000
WDA @ 18% (1,080) 1,080
Tax written down value c/fwd at 31.3.16 4,920

His 2015/16 trading income is therefore:

Adjusted profits before capital allowances 5,200

Less: Capital allowances (1,080)
Trading Income 4,120

This is covered by the personal allowance for 2015/16 so no tax is payable.

Instead Paul could disclaim his capital allowances. The CA computation would
now be:

General CA claim
Pool
£ £
Year ended 31 March 2016:
Tax written down value b/fwd at 1.4.15 5,000
Plant & machinery additions:
– Ladders 1,000
6,000
WDA claimed (Nil) Nil
Tax written down value c/fwd at 31.3.16 6,000

His 2015/16 trading income is now:

Adjusted profits before capital allowances 5,200

Less: Capital allowances (Nil)
Trading Income 5,200

Again this is covered by the personal allowance for 2015/16 so no tax is payable.
However, Paul now has a higher tax written down value to carry forward to
2016/17.

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EXAMPLES

 Example 1

Andy is a self-employed painter and decorator. He has a year-end of 31 October.

The tax written down value of the general pool at 1 November 2014 was £8,000.
On 25 July 2015, Andy bought new ladders for use in his trade costing £2,000. He
sold his old ladders for £200.

Calculate Andy's capital allowances for the year ended 31 October 2015.

 Example 2

Lynette started trading on 1 May 2015 making stained glass windows. She bought
some machinery on 30 May 2015 for £10,000. On 1 November 2015 she signed a
contract to buy a specialist cutting machine costing £14,000. She paid a 50%
deposit on delivery on 20 November 2015 and the balance on 1 February 2016.

She drew her first accounts to 31 December 2015.

Calculate Lynette's capital allowances for the period ended 31 December 2015.

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ANSWERS

 Answer 1

The capital allowances computation will be:

General CA claim
Pool
£ £
Year ended 31 October 2015:
Tax written down value b/fwd at 1.11.14 8,000
Plant & machinery additions:
– New ladders 2,000
10,000
Disposals:
– Old ladders (200)
9,800
WDA @ 18% (1,764) 1,764
Tax written down value c/fwd 8,036

 Answer 2

General CA claim
Pool
£ £
8 months ended 31 December 2015:

Plant & machinery additions:

– Machinery (May 2015) 10,000
– Cutting machine (November 2015) 14,000
24,000
WDA @ 18% × 8/12 (2,880) 2,880
Tax written down value c/fwd 21,120

Tutorial Notes:

1. Balance of payment on cutting machine within 4 months of delivery, so all

expenditure deemed to be incurred on 20 November 2015.

2. 8 month AP, therefore restrict WDAs.

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