Purchasing machinery is a huge financial commitment and when timed right can be extremely tax eﬀicient. In years where there has been a good harvest, re-investing some of that profit into new plant and machinery before the end of the year is one of the best tools to reduce your tax liability.
Capital allowances let businesses write off the cost of certain capital assets against taxable income. They take the place of accounting depreciation, which is not normally tax-deductible. Relief is given for the drop in value of an item whilst the business owns it: timing is key to achieve the best from the rules.
Annual Investment Allowance (AIA)
The AIA allows for machinery used in a business to qualify for 100% tax relief in the year of acquisition up to an annual limit, effectively allowing businesses to treat the expense as a revenue deduction. This limit is £1,000,000 up to 31 March 2023.
A partnership incurring expenditure of £100,000 on a second hand tractor will mean the partnership can deduct £100,000 from its taxable profits potentially saving tax and national insurance at higher rates of 43.25% – a tax saving of £43,250 for a higher rate taxpayer.
Whilst cars are specifically excluded from AIA relief, certain vehicles such as a double cab pick-up with a payload of one tonne or more can qualify for AIA.
The AIA is available to all businesses although in some circumstances related businesses and group companies may need to share one allowance across multiple businesses.
Assets purchased from a connected party, even at market value, do not qualify for AIA. This situation typically arises where farming equipment is owned personally but sold to a connected contracting company.
Writing down allowances (WDA)
Writing down allowances can be claimed where expenditure exceeds the AIA limit or where expenditure doesn’t qualify for AIA, for example, cars. The rate of writing down allowance is either 18% for qualifying main pool assets or 6% for qualifying items, which fall into the special rate category e.g. solar panels. Typically, plant and machinery, including vans, qualify for 18% WDA’s (main pool) and cars qualify for 6% WDA’s (special rate pool).
What if I part-exchange farming machinery?
On a subsequent sale/part exchange of the asset on which AIA has been claimed, the proceeds of sale are deducted from the tax pool rather being automatically taxable. How- ever it will become taxable if the disposal proceeds are greater than the tax pool. This is why timing of acquisition and disposal is crucial.
You part exchange an old tractor worth £50,000 against the price of a new one worth £120,000.
£50,000 will be deducted from your tax pool. If the tax pool stands at £5,000, it will create a £45,000 balancing charge, which is added to your taxable profit. However, the amount of AIA which can be deducted from your taxable profit is £120,000. Taxable profits overall are reduced by £75,000.
Timing tip: With second hand prices good, and replacement kit difficult to find, it is tempting to sell before you buy the replacement. Avoid selling kit in one accounts year and buying the replacement in the next!
Timings of payments
To ensure that tax relief is obtained at the earliest opportunity on capital expenditure, if an asset is being purchased outright, with no finance, the acquisition date for tax purposes is the date on which the obligation to pay becomes unconditional, which is usually the date the invoice is issued. There is an exception to the general rule. If there is a gap of more than four months between the invoice date and 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.
A farmer with a 31 March year-end buys a new machine costing £100,000 for use in the trade. Under the terms of the contract £75,000 has to be paid 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 2022 and the obligation to pay becomes unconditional then. He is legally required to pay £75,000 on 21 April 2022, and £25,000 on 21 September 2022.
The first payment is due four months or less after the obligation to pay becomes unconditional but the second one is not. He therefore “incurs” expenditure of:
£75,000 on 21 March 2022 – addition in the year ended 31 March 2022; and
£25,000 on 21 September 2022- addition in the year ended 31 March 2023.
If an asset is to be acquired with hire purchase, the acquisition date for tax purposes is the date that 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.
The machinery must have been delivered and used before the relevant date for a tax deduction to be obtained, and the hire purchase must be on “normal” payment terms. For more seasonal machinery such as combines and balers, where chargeable periods end in the spring (31 March / 5 April, for example) if acquired in an off-season winter deal, the likelihood is that the kit will not have been brought into use at the year end. As a result tax relief in the acquisition period will be restricted only to the payments made, with the rest of the allowances claimed once brought into use.
Particularly when a generous trade in deal is being offered to “oil” the deal, this can be an expensive tax trap.
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.
Timing tip: loan finance makes you a cash purchaser, and not subject to these rules. Factor this in when comparing the cost of loan and HP/ merchant finance.
First Year Allowances (FYA)
FYAs give businesses an enhanced rate of capital allowances on plant and machinery in the accounting period in which the expense is incurred.
The following types of expenditure attract FYAs at 100%:
- expenditure incurred before 6 April 2023 on plant and machinery for an electric vehicle charging point;
- expenditure incurred before 1 April 2025 on new cars with zero C02 emissions or zero-emission goods vehicles;
- capital expenditure incurred on research and development.
What is super-deduction relief?
From 1 April 2021 until 31 March 2023, companies invest- ing in new moveable plant and machinery assets will benefit from a 130% first-year capital allowance, in addition to the £1m AIA. This upfront super-deduction will allow companies to cut their tax bill by up to 25p for every £1 they invest.
Partnerships and sole trades will not qualify for the super-deduction of 130%.
Timing tip: for an unincorporated business, anything that reduces Income Tax has a knock-on effect on tax payable on account, increasing the cash flow saving by a further 50%.
Make sure you take advice before signing any deal to ensure you are in the best tax position possible. Timing and strategy are key to maximise the taxman’s contribution but always consider business needs first.
Information for readers: This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.