John Harrison and Company - Charter Accounts

This briefing considers recent developments and announcements in the core area of plant and machinery capital allowances including the important forthcoming changes for 2012. Opportunities for maximising relief and avoiding pitfalls are highlighted, including the critical issues of timing and identification of qualifying capital expenditure.

1 April 2011 welcomed in a reduction of corporation tax rates of at least one percent for all companies. However, to pay for the cost of that reduction, two key changes to capital allowance rates on plant and machinery are set to impact from April 2012. These changes affect not only companies but all qualifying businesses that claim capital allowances.

Changes to the Annual Investment Allowance (AIA)

The AIA provides 100% tax relief on most types of plant and machinery (not cars) including integral features for all forms of qualifying business. ince April 2010 the maximum annual limit available has been £100,000 but this is to reduce to £25,000 for expenditure incurred on or after 1 April 2012 for companies and 6 April 2012 for the self-employed in business. An apportionment of the limits is required if the accounting period straddles 1 or 6 April 2012. This will be the case for many businesses.

However, a restriction is set so that, for expenditure incurred in the part of the accounting period falling on or after 1 or 6 April 2012, the maximum entitlement is given only by reference to the appropriate share of the £25,000 limit.

Using Company P in example 1 this would be £25,000 x 6/12 = £12,500.

 

Changes to Writing Down Allowances (WDAs)

Annual WDAs are available to relieve qualifying plant and machinery expenditure not relieved by other capital allowances such as AIA. There are two rates. A rate of 20% for plant and machinery generally. This includes cars up to and including 160 CO2 emissions and a 10% rate for the special rate pool which applies to integral features, long life plant and cars in excess of 160 CO2 emissions.

These WDA rates are to reduce from 1 April 2012 for companies and from 6 April 2012 for the self employed.

The annual rates will move from:

• 20% to 18% on expenditure allocated to the main plant pool and
• 10% to 8% on expenditure allocated to the special rate pool.

Hybrid rates apply for accounting periods which span 1 or 6 April 2012. The example below demonstrates the principle of how this operates but in practice this calculation has to be done on a strict daily basis.

The effect of these changes will mean that the period over which tax relief is obtained is longer than previously. In fact according to the Government - ‘It is estimated that approximately 2 million businesses could see an increase in their tax liability as a direct result of this measure.’ So, taking advantage of other opportunities, which may accelerate capital allowances and the corresponding tax relief, becomes more pertinent. One such way of obtaining more capital allowances earlier is to make a ‘short life asset’ election where this is available.

Short life assets (SLA)

An asset which qualifies to be treated as a SLA can be separately pooled. This means that it is isolated for tax relief purposes from the main plant pool. Initially it is eligible for the same allowances (AIA and WDA) as would have applied if placed in the main plant pool. However, on disposal, where there is unrelieved expenditure after taking disposal proceeds into account, an extra allowance can be claimed for the unrelieved amount. This equates to writing off the whole of the cost (less disposal proceeds) of the asset over the actual economic life of that asset to the business.

A change which improves the relief!

The SLA facility has been available for many years but in the context of the 2012 reductions considered earlier - a second look at what is eligible may reap benefits. Furthermore, a surprise announcement in the Budget earlier this year has improved the scope for using this relief.

Up until now it has only been possible to make a SLA election on assets with an expected useful life to the business of four years or less from the end of the accounting period of acquisition. Therefore if the commercial vehicle in example 3 had been retained for one or two more years in the company business then it would become ineligible for SLA treatment and no additional allowance would have been granted on disposal.

This lifetime period has now been extended to eight years from the end of the accounting period of acquisition for additions on or after 1 April 2011 for companies or 6 April 2011 for the self-employed. This makes it more useful as it means more assets could benefit from a SLA election.

Two points to watch

First, a SLA election should only ideally be made on assets which are likely to lose value quicker than they receive tax relief. This is because where assets hold their value well this could result in a ‘clawback’ of some or all of the tax relief given.

Second, not all qualifying expenditure qualifies. Some assets are specifically excluded. The key (but not only) exceptions are cars, integral features and long life assets. Please contact us for further guidance on exclusions.

Timing of capital expenditure

The impending AIA reduction sharply brings into focus the importance of identifying the correct date for qualifying capital allowance expenditure. The normal rule is that expenditure is incurred on the date on which the obligation to pay becomes unconditional. This will often be the date goods are delivered.

There is an exception to this general rule. If there is a gap of more than four months between the date on which the obligation to pay becomes unconditional 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.

What AIA is due?

The knock on effect of the above is that instead of the £100,000 being wholly covered by AIA in the year to 5 April 2012, the following occurs:

• £50,000 AIA is available on the first £50,000 in the year to 5 April 2012 providing 100% tax relief.
• Only £25,000 of the second £50,000 will qualify for AIA (due to the reduction in the limit) and the balance will attract WDA only.

Ensure claims are not missed

One hot topical issue concerns ‘fixtures and fittings’ in second hand building purchases. The need for accurate allocation of expenditure to those elements and identification of eligibility for plant and machinery capital allowances means that claims can initially be missed.

However, due to the fact that there is currently no time limit on when expenditure on plant or machinery, including fixtures, needs to be pooled, this means that such expenditure on fixtures can be pooled some years after the fixtures were acquired.

This facility to make ‘late’ claims, several years after a property acquisition may mean, due to the lack of relevant information available to HMRC about the previous owner’s claims, that capital allowances are given to the current owner (as well as a previous owner).

Government may call time

Due to the above, the Government is considering the following proposals:

• a requirement that businesses must pool their expenditure on fixtures within a short period after acquisition, in order to qualify for capital allowances and
• that, in order to qualify for capital allowances, the purchaser of a second hand building must agree with the seller the amount of the sale price attributable to the fixtures, and that both the purchaser and the seller should record and formally notify this to HMRC within a similar timescale.

Further, in respect of expenditure already incurred on such fixtures, before any changes in the law come into effect, the Government is considering whether businesses should also be required to pool that expenditure within one or two years of the commencement of the mandatory pooling requirement for new expenditure.

If these proposals go ahead, early action to ensure that all relevant building purchases have been reviewed may become necessary to secure capital allowance claims.

Please do contact us for tailored capital expenditure and allowance advice for your business requirements so that tax savings can be maximised.

 

Disclaimer - for information of users - This briefing 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 contained in this briefing can be accepted by the authors or the firm.

 

Our clients are reminded that if they use a business car for mixed business and private usage, the MUST keep a mileage log showing each journey and whether it is business or private so that the correct apportionment of expenses can be made.

If a private car is used for business purposes it is merely necessary to kep a log of business journies.By concession the self emplyed can claim the same 45p mileage rate that employed persons claim.

In our experience, in every case that H M Revenue and Customs investigate a taxpayer's affairs, motoring expenses are scrutinised and if proper records are not kept at least some expenses are bound to be disallowed and this enables HMRC to reopen all of the last six in date years, charge the additional tax and with interest and penalties this can add up to quite a sum of money.

At John Harriosn and Company we have a stocked of printed mileage record books available free of charge for our clients. If you want one, call us on 01909 472310.

This briefing focuses on VAT matters of relevance to the smaller business. A primary aim is to highlight common risk areas as a better understanding can contribute to a reduction of errors and help to minimise penalties. Another key ingredient in achieving that aim is good record keeping, otherwise there is an increased risk that the VAT return could be prepared on the basis of incomplete or incorrect information. This aspect is not considered further here but useful guidance can be found in www.hmrc.gov.uk/factsheet/record-keeping.pdf

Input VAT matters

Only registered traders can reclaim VAT on purchases providing the expense is incurred for business purposes and there is a valid VAT invoice for the purchase. Only VAT registered businesses can issue valid VAT invoices. VAT cannot be reclaimed on any goods or services purchased from a business that is not VAT registered. Proforma invoices should not be used as a basis for input tax recovery as this can accidentally lead to a duplicate VAT recovery claim.

Most types of supply on which VAT recovery is sought must be supported by a valid VAT invoice. This generally needs to be addressed to the trader claiming the input tax. A very limited list of supplies do not require a VAT invoice to be held to support a claim, providing the total expenditure for each taxable supply is £25 or less (VAT inclusive). The most practical examples of these are car park charges and certain toll charges.

The following common items however never attract input VAT and so no VAT is reclaimable - stamps, train, air and bus tickets, on street car parking meters and office grocery purchases like tea, coffee and milk!

Business purpose

This is often an area of contention between taxpayers and HMRC as VAT is not automatically recoverable simply because it has been incurred by a VAT registered person. In assessing whether the use to which goods or services are put amounts to business use (for the purpose of establishing the right to deduct input tax), consideration must be given as to whether the expenditure relates directly to the function and operation of the business or merely provides an incidental benefit to it.

Private and non-business use

In many businesses, personal and business finances can be closely linked and input tax may be claimed incorrectly on expenditure which is partly or wholly for private or non-business purposes.
Typical examples of where claims are likely to be made but which do not satisfy the ‘purpose of the business’ test include:

• expenditure related to domestic accommodation
• pursuit of personal interests such as sporting and leisure orientated activities
• expenditure for the personal benefit of company directors/proprietors and
• expenditure in connection with non-business activities.

Where expenditure has a mixed business and private purpose, the related VAT should generally be apportioned and only the business element claimed. Special rules apply to recover input tax claimed on assets and stock (commonly referred to in VAT as goods) when goods initially intended for business use are then put to an alternative use.

Example: Three laptops are initially bought for the business and input VAT of £360 in total is reclaimed. One is then gifted by the business owner to his son so VAT will have to be accounted for to HMRC of £120 (1/3 x £360)

Business entertainment

VAT is not reclaimable on many forms of business entertainment but VAT on employee entertainment is recoverable. The definition of business entertainment is broadly interpreted to mean hospitality of any kind which therefore includes the following example situations:

• travel expenses incurred by non employees but reimbursed by the business, such as self employed workers and consultants
• hospitality elements of trade shows and public relations events.

Business gifts

A VAT supply takes place whenever goods change hands, so in theory any goods given away result in an amount of VAT due. The rule on business gifts is that no output tax will be due, provided that the VAT exclusive cost of the gifts made does not exceed £50 within any 12 month period to the same person.

Where the limit is exceeded, output tax is due on the full amount. If a trader is giving away bought-in goods, HMRC will usually accept that he can disallow the tax when he buys the goods, which may be more convenient than having to pay output tax every time he gives one away.

Routine commercial transactions which might be affected include such things as long service awards, Christmas gifts and prizes or incentives for sales staff.

Cars and motoring expenses

Input tax errors often occur in relation to the purchase or lease of cars and to motoring expenses in general. Some key issues are:

• Input VAT is generally not recoverable on the purchase of a motor car because it is not usually exclusively for business use. This prohibition does not apply to commercial vehicles and vans, provided there is some business use.
• Where a car is leased rather than purchased, 50% of the VAT on the leasing charge is not claimed for the same reason.
• Where a business supplies fuel or mileage allowances for cars, adjustments need to be made to ensure that only the business element of VAT is recovered. There are a number of different methods which can be used, so do get in touch if this is relevant to you.

Output VAT issues

Bad debts

Selling on credit in the current economic climate may carry increased risk. Even where credit control procedures are strong there will inevitably be bad debts. As a supplier, output VAT must normally be accounted for when the sale is initially made, even if the debt is never paid, so there is a risk of being doubly out of pocket.

VAT regulations do not permit the issue of a credit note to cancel output tax simply because the customer will not pay! Instead, where a customer does not pay, a claim to recover the VAT on the sale as bad debt relief can be made six months after the due date for payment of the invoice.

Example: A trader supplies and invoices goods on 19 October 2010 for payment by 18 November 2010 (ie a normal 30 day credit period). The earliest opportunity for relief if the debt is not settled would be 18 May 2011. The relief would be included in the return into which this date fell, depending on the return cycle of the business.

The taxpayer can only claim relief for the output tax originally charged and paid over to HMRC, no matter whether the rate of VAT has subsequently changed. In the above example the standard VAT rate charged would have been 17.5% (not the current 20%) so a claim can be made for only 17.5%. The claim is entered as additional input VAT - treating the uncollected VAT as an additional business expense - rather than by reducing output VAT on sales.

The customer

A customer is automatically required to repay any input VAT claimed on a debt remaining unpaid six months after the date of the supply (or the date on which payment is due if later). Mistakes in this area are so common that visiting HMRC officers have developed a programme enabling them to review Sage accounting packages and to list purchase ledger balances over 6 months old for disallowance.

Preventing the problem?

Small businesses may be able to register under the Cash Accounting Scheme, which means you will only have to account for VAT when payment is actually received. The scheme is considered in more detail later in this briefing.

Special schemes for the smaller business

Several special schemes relate to smaller businesses. These are mainly aimed at reducing the compliance burden.

The Flat Rate Scheme (FRS). FRS is an attempt to simplify VAT accounting for the small or growing business. This optional scheme provides currently registered traders with an alternative mechanism for accounting for VAT, and offers an additional incentive for new registrations. The scheme enables eligible businesses to calculate their VAT payment as a flat percentage of total turnover. The percentage to be used depends on the type of business activity carried on. If the business is newly registered for VAT and also decides to operate this scheme then a further 1% flat rate reduction applies in that first year of registration. The scheme is generally open to small businesses whose annual taxable turnover excluding VAT does not exceed £150,000. Traders must now leave the scheme when their taxable turnover (including VAT) exceeds £230,000. This calculation must be made annually on the anniversary of the trader joining the scheme. 

Annual Accounting Scheme. The Annual Accounting Scheme is also generally aimed at the smaller business. It can either be combined with FRS (described above) or used by a business which uses standard VAT accounting. The scheme allows the business to complete just one VAT return each year, instead of the usual four. However, it retains a smooth cash flow position as instalment payments of the expected VAT liability are made on account, so that the business is not faced with a large VAT bill at the end of the year. A choice of three (quarterly) or nine (monthly) instalments can be made towards the end of year VAT liability. These must be paid by direct debit, standing order or other electronic means. A business with a taxable turnover up to £1.35 million can apply for entry into this scheme.

Cash Accounting Scheme

Another popular small business scheme is the Cash Accounting Scheme. Under standard VAT accounting, VAT is payable on sales whether or not the customer has paid and can lead to a need to claim bad debt relief (as detailed earlier). Under this scheme VAT does not need to be paid over until the customer has paid. If the customer does not pay then the VAT is not payable. This clearly has cash flow benefits for traders which sell on credit. A business can enter this scheme provided the estimated VAT taxable turnover for the next VAT year is not more than £1.35 million. It can continue to use the scheme until the VAT taxable turnover exceeds £1.6 million. Where your business is registered under the Cash Accounting Scheme, do remember that this also means that VAT cannot be claimed on purchases and other inputs until you have actually made the payment, rather than the standard method of accounting for the reclaim when you receive the invoice. 

We can advise you if this scheme would be suitable for your business.