Many farmers will have heard about upcoming changes to the ‘Annual Investment Allowance’, but not everyone understands what this is, and how it might be relevant to your business.
A common misconception is that the net profit shown by the annual accounts is the figure used to calculate the business’ income tax liability, but in fact this isn’t true in most cases. When you consider how the accounts are prepared, this isn’t as surprising as you might first think…
Your business accounts are prepared in accordance with a set of international accounting standards which are intended to provide consistency in how financial accounts are presented across the world. However every country has its own tax regime, and the tax rules can change very frequently. Therefore whilst your accounts are prepared using this relatively stable set of international accounting principles, your tax return is prepared according to the frequently changing rules of the UK tax authorities. The two might be similar, but they aren’t identical.
In a farming business one of the most significant differences between your financial accounts and the income tax computation, is the way in which plant and equipment is treated. In your P&L accounts the plant and equipment will be ‘depreciated’, most likely using the reducing balance method. This means that an estimate is made of the portion of the machine’s initial cost considered attributable to that accounting year. The calculation is designed in such a way as to apportion the greatest amount to the years soonest after purchase (the rate at which a piece of equipment reduces in value reduces over time). The ‘depreciation’ for a piece of equipment appears as an expense in your P&L account, and commonly a figure of between 15 and 25% depreciation will be used.
Whilst depreciating these assets is the internationally recognised convention when preparing financial accounts that show a ‘fair and true’ picture of the trading of the business, for current UK income tax purposes, depreciation is not ‘allowable’ and will be added back to the net profit when making tax calculations. Businesses are instead able to use the Annual Investment Allowance (AIA), a tax incentive designed to encourage investment in plant and machinery. The AIA permits a business to offset the full initial price of qualifying items of plant and equipment, up to an annual limit, against business profits – the business is then taxed on this (often very greatly) reduced amount.
AIA is available on a wide range of plant and equipment, including most tractors, implements, and commercial vehicles (but not cars). The limit allowed in any tax year has fluctuated over the years but was £200,000 in 2018 before being extended to £1 million for a period of two years. This two year period concludes on 31 December 2020 after which the AIA goes back down to £200,000.
Where you are intending to invest in plant and equipment in the coming months it is essential you contact your accountant ASAP. There are transitional rules around the reduction of the AIA which can result in allowances being lost (even if the business is still under the £200k threshold) where the year-end straddles 31 December 2020. The timing of investment is critical and your timely communication will ensure you don’t lose out!
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