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July 19, 2018
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"Keep Capital Allowances" says OTS

The Office of Tax Simplification (the "OTS") has concluded its review on whether depreciation should replace capital allowances ("CAs") for tax purposes, and has found that whilst deductions for depreciation would simplify the system and more accurately reflect the underlying cost of assets, this would not outweigh the disruption such a change would cause.

Background

Under the current rules, a business recognises the reduced value of an asset in its accounts by including deductions for depreciation. Furthermore, deductions are made to account for the purchase of new capital assets.

However, when calculating its taxable profits, the business is required to add back expenditure incurred on the acquisition of assets and any depreciation deducted.

With this in mind, CAs are available to account for these costs. Relief is provided by treating the allowance as a deductible expense when calculating the taxable trading profits of a business at a rate of between 8% - 100% of the original cost of the asset, depending on its nature. See our page on capital allowances for more information.

The OTS found that CAs were an area that caused confusion for taxpayers.  In particular, a major source of confusion stemmed from the difficulty determining whether or not an asset qualifies for CAs and the actual rate of relief that should apply.

Findings of OTS 

The OTS concluded that whilst replacing CAs with depreciation would simplify the process and give a better representation of the underlying economic cost of an asset, these benefits would be outweighed by the disruption the change in the rules would cause.

One of the most generous aspects of CAs is the 100% relief available under the Annual Investment Allowance ("AIA") for purchases of qualifying assets.

The OTS noted that most taxpayers spend less than the maximum AIA each year which left only 30,000 taxpayers with expenditure falling under the other rates of relief.

The OTS recommended the government consider changing how CAs are calculated to simplify the existing system. Recommendations include:

  • Ensuring that tax follows accounts for the capital/revenue distinction.
  • Introducing a small capital exemption to allow 100% deduction for capital expenditure worth less than £1,000 per item.
  • Developing specific guidance of all assets qualifying for CAs as a single point of reference.
  • Improving the current non-statutory clearance process regarding the CAs regime.
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