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February 27, 2023

£1m Annual Investment Allowance Extension: The Immediate Practical Effect for Businesses

£1m Annual Investment Allowance Extension: The Immediate Practical Effect for Businesses

What is the Annual Investment Allowance (AIA)?

The annual investment allowance (AIA) is a type of capital allowance and is available for all businesses. The AIA is intended to ‘encourage greater levels of investment by reducing the costs of capital’ (CAA 2001, s.38A). The AIA gives 100% allowance (i.e., a tax deduction) for qualifying investment in plant & machinery (P&M) (excluding cars) up to a specified amount.

In the 2021 Autumn Budget, Rishi Sunak announced that the temporary increase of the AIA to £1 million would be extended until the 31 March 2023 and later, in October 2022, Jeremy Hunt, the new Chancellor, confirmed that the £1m AIA limit would remain permanently.

Issues of the permanent increase of the AIA limit

Whilst the permanent increase of the AIA limit to £1 million appears to be beneficial for many businesses (namely those with accounting periods running to 31 March), the increase poses some issues during the transition period.

Firstly, for businesses with a 12-month accounting period running to 31 March, the transition on 1 April 2023 to the permanent AIA limit of £1 million will be seamless.

However, for businesses with accounting periods that straddle the 1 April 2023, the maximum amount of AIA available could be significantly reduced. This is due to the way that the legislation, which determines the maximum AIA available to businesses in a chargeable period which straddles 1 April 2023, has been drafted (Finance Act 2019, Schedule 13, Para 2).

Therefore, many businesses may unwittingly go over their allowances this year, and careful tax planning along with the timing of P&M expenditure is needed to ensure that businesses with accounting periods that straddle the 1 April 2023 benefit from the maximum AIA available to them.

How does the legislation work in practice?

Due to Paragraph 2 of Schedule 13 of the Finance Act 2019, businesses with accounting periods running both before and after the 1 April 2023, will only be eligible for a pro-rata portion of the AIA in each period.

For the period before 31 March 2023, businesses can ‘borrow’ the pro-rata proportion from after 1 April 2023, creating the full £1m available for qualifying expenditure incurred before 31 March 2023.

However, this does not apply in reverse and businesses cannot ‘borrow’ any unused allowance from before 1 April 2023. This means a business with a calendar year accounting period ending on 31 December 2023 may incur all its qualifying expenditure after 1 April 2023, and not realise that its maximum allowance would only be £750,000 (9/12 of £1m).

Businesses that are unaware of the effect of pro-rating the second straddling period from 1 April 2023, could find that they have exceeded their maximum AIA. In this case, any excess expenditure would need to go into the main pool (18%) or special rate pool (6%) meaning that it will take several years to write off the balance. Understandably, this could come as a shock to many businesses who may be relying on the AIA to improve cash flow following large amounts of capital expenditure.

Therefore, there are several factors businesses should take into consideration when planning their P&M expenditure this year.

How will this affect businesses claiming the AIA this year?

  • Businesses wanting to claim the AIA this year should firstly consider whether their accounting period straddles the 1 April 2023 as the £1 million allowance will need to be pro-rated for the second straddling period (i.e., from 1 April 2023 onwards).
  • Secondly, business with an accounting period that straddles the 1 April 2023 should consider how long the second straddling period is (i.e., 1 April 2023 – end of accounting period) and compare the time-apportioned AIA to their planned P&M expenditure. For example, a business with an accounting period to 31 December 2023 will be entitled to £750,000 (9/12 of £1m) which is enough AIA for most businesses. However, a business with an accounting period ending on 31 May 2023 will be entitled to just £166,666 (2/12 of £1m) for expenditure incurred from 1 April – 31 May 2023.
  • If possible, business owners may find it effective to time the purchase of P&M to a period in which they will receive the full £1m AIA. For example, timing the purchase of all qualifying expenditure so that is incurred before the 31 March 2023.
  • If all the expenditure is incurred on or after 1 April 2023, only the limited allowance is available and that will vary with the end date of the second straddling period as explained above.

In conclusion, the assumption of a seamless transition to the permanent £1m AIA limit, is not supported by the relevant legislation. In some circumstances, the application of the legislation will have no practical effect as P&M expenditure will not exceed the reduced AIA limit. In other cases, businesses which are not expecting to suffer from a reduced time-apportioned AIA limit, and have not timed P&M expenditure accordingly, may find that cash flow is significantly affected.

If you’d like any further information regarding capital allowances or the AIA, please contact a member of our team.

Disclaimer: This article is for general information purposes only and is not intended to constitute individual advice. It is recommended that you seek independent tax advice.

Contact us today to discuss your tax requirements.
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