The annual investment allowance (AIA) is a capital allowance which allows a 100% tax deduction for qualifying expenditure (most expenditure which qualifies for capital allowances) incurred in an accounting period.

This relief is normally capped at £200,000 per annum but was temporarily increased to £1,000,000 for each of the two years ended 31 December 2020, before reverting to £200,000 for subsequent periods.

Companies have got used to the AIA at the higher level of £1,000,000 and given that the AIA will change at the end of this year it is important to be mindful of this reduction to avoid being caught.

In particular it is important to how the transitional rules work as they can give rise to a nasty surprise.

Transitional rules

The formula for working out the AIA for any accounting period which spans 31 December 2020 is:

(m/12 x £1,000,000) + (t/12 x £200,000)

Where ‘m’ is the number of months in the accounting period that arise on or before 31 December 2020 and ‘t’ is the number of months in the accounting period that arise after 31 December 2020.

This seems simple enough but extra care is required as the AIA is capped at the proportion of the AIA limit which is applicable to each part of the accounting period (see the example below).

Example

A company has an accounting period from 1 July 2020 to 30 June 2021. The finance director duly calculates the AIA limit using the formula above:

(6/12 x £1,000,000) + (6/12 x £200,000) = £600,000.

In April 2021 the FD gets round to reviewing AIA headroom. As £100,000 was spent in the first half of the year they conclude that up to £500,000 of expenditure before the year end will qualify.

Wrong! Only £100,000 can qualify because that is the limit for that part (post 31 December 2020) of the accounting period. This misunderstanding has led to the potential loss of £400,000 of AIAs. The relief would then take over 10 years to be realised under normal capital allowances rules.

On closer inspection of the rules the finance director realises that they should have achieved the extra £500,000 of expenditure in the second half of 2020, i.e. before 31 December 2020.

Planning

The lesson here seems to be that companies should review their expenditure projections so as to incur expenditure before the end of 2020 where possible. Planning for this issue will need to start very soon and our tax team are on hand to help.

It does not make good tax sense for significant qualifying expenditure to be incurred in early 2021 when full AIAs have not been used in 2020.

 

Tax Planning