can aia create a loss?

As you probably know, the timing of tax deductions for the cost of equipment etc. which you use in your business is dictated by HMRC’s capital allowances (CAs) rules. CAs are tax deductible in place of the depreciation charges included in your accounts. One of the particularities of CAs is that you can choose not to claim them. In that case tax relief isn’t lost as you can claim it in later years instead.

Tip. There are a few situations where it’s tax efficient to not claim CAs, especially if your business is unincorporated. Otherwise it can result in you receiving less tax relief in the long run.

Where you run your business through a company you might consider not claiming CAs if, for example, it made a loss. This is because while CAs increase a loss, it will only have an immediate tax advantage if you can set it against profits. Losses can only be set against profits of the previous financial year or for future years.

If there’s no immediate tax advantage to claiming CAs, you might be tempted not to bother. The trouble is the rate at which CAs are given is significantly slower because the right to use the annual investment allowance (AIA) is lost.

Trap. The AIA allows you to claim tax relief for 100% of expenditure on equipment etc. in the accounting period in which it was purchased. However, the right to the AIA is lost if it’s not used for that year. Instead, CAs at either 8% or 18% of the expenditure are allowed in subsequent years.

Example. Acom Ltd spends £100,000 on machinery for its workshop in May 2021. It can claim CAs using its AIA for the entire £100,000 in its 2021 accounts. If it chooses not to, it can claim CAs in any later year, but only at a maximum of 18% per year of the reduced balance, i.e. 18% of £100,000 (£18,000), followed in the next year by 18% of £82,000 (£14,760). It will be a very long time before Acom gets tax relief on £100,000.

Tip 1. Claim CAs even if you won’t get immediate tax relief for them. They can be added to a trading loss which will be set against the first taxable profit in future years, or they can be carried back to reduce earlier profits of the previous year.

Tip 2. Since 1 April 2017, there are a number of things that can be set off against total profits going forward. These include trading losses, non-trading deficits on loan relationships, management expenses, UK property losses and non-trading losses on intangible fixed assets. Losses in an individual company can also be carried forward and set off against profits of other group companies. Plus, for companies and unincorporated businesses losses arising from 1 April 2021 can be carried back up to three years to reduce tax paid on profits from the same business.

Forget-me-not. If, for any reason, you decide not to claim CAs for the cost of equipment etc., don’t forget to add it to the pool of expenditure which is carried forward and on which you can claim CAs in later years.

The recent decision in Stephen May v HMRC UKFTT 32 (TC) deemed a grain silo structure to be apparatus and allowed capital allowances to be claimed accordingly. This timely ruling may well be welcome news to farmers looking to take advantage of this new limit.

For unincorporated businesses such as farming there is an opportunity to claim the AIA and offset against profits. Such a claim for AIAs often creates a tax loss, especially where farm profitability has been suffering. The problem with creating a tax loss with the AIA is the 25% cap of loss claims against total income.

The UK tax system recognises the farming taxpayer’s right to offset losses sustained in farming against what would otherwise be his taxable income, so as to extinguish or reduce the tax due on that income. The result of the aggregation of trading losses with income may be to “discharge” (ie cancel) tax liabilities due on that income, or to create repayment of income tax already paid. HMRC does not allow the tax relief on losses without question, and evidence and documentation where there are concerns is required. Original business plans to show the business would and could make money and how this would be achieved is essential.

Under the provisions of Finance Act (FA) 2013, legislation was introduced with effect from 6 April 2013 to apply a cap on income tax reliefs claimed by individuals. The cap applies to anyone seeking to claim more than £50,000 tax loss reliefs with the cap at 25% of income, or £50,000 if greater. The following reliefs are restricted:

The maximum amount the farmer will be able to claim in one tax year where the AIA creates a loss will be the greater of £50,000 and 25% of their income. Income is defined, in this instance, as their total income liable to tax, adjusted to include a deduction for the individual’s charitable donations through a payroll giving scheme, and to also exclude pension contributions, to give an adjusted total income. Thus, a farmer with an adjusted total income of £400,000 will only be able to offset a tax loss claim up to £100,000 (25% of £400,000), leaving £300,000 (£400,000–£100,000) still subject to Income Tax.

Interestingly the 25% cap on losses to be offset does not apply to the offset against a Capital Gains Tax (CGT) liability. For example, an Income Tax loss when set against a capital gain does not have to be restricted. Until FA 1991, farming losses were not able to be offset against CGT liability. This rule seriously affected the ability of farmers to sell surplus assets so as to raise cash to reduce their bank borrowings. Relief was enacted in s72 FA 1991, when the stated purpose was to bring unincorporated businesses into line with companies, which could already set trading losses against both income and their capital gains. This form of tax loss relief is now found in ITA 2007 s71.

It is only the trading losses of the year of sale which create the gain, or the year preceding the year of sale which creates the gain, which are available to offset against the gain. Any trading loss which is not set against income or gains of the current or succeeding year are available to be carried forward and set against future trading profits.

Another element of the 2018 Budget (now Finance Act 2018) that has seemed negative for “buy to let” property is the loss of “lettings relief”. This relief currently exempts from CGT gains accruing in a period when the main residence is let out up to a maximum of £40,000. This relief will now be restricted to apply only to periods where the owner jointly occupies the property. Together with the loss of the “buy to let” interest, there are now incentives to sell let property.

A strong tax-planning opportunity could be for a farmer to spend the maximum amount on AIA they can budget for, create a tax loss and then use this to offset against sales of non-business residences, saving tax at a rate of 28%. This also has the additional tax advantage of reducing investments that may not qualify for IHT relief. For example, “buy to lets” are unlikely to qualify, even under Balfour - Commissioners for HMRC v AM Brander (as executor of the Will of the late 4th Earl of Balfour) UKUT 300 (TCC), or they may tip the balance more in line with an investing business rather than a trading one. As such, removing assets like these with the increasing number of tax disadvantages is certainly worth some thought. Whilst saving tax at 28% CGT on residential property is not as high as the Income Tax rate for additional rate taxpayers at 45%, it still warrants a very balanced tax consideration.

It's a relatively simple concept.

Profits before capital allowances and personal allowance - say £8K.

Capital allowances (AIA and/or WDA) available say £16K.

If the full £16K is claimed (or even hypothetically £8K) the personal allowance is wasted which at a marginal rate of tax of say 30% (including N.I.) results in an extra tax bill of £2,400.

I accept that the capital allowance relief will be spread over many years but you could argue that this situation could occur more than once.

Planning around capital allowances and the personal allowance is one of the few bits of excitement I get these days!