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Super-deduction – a financial marvel?

The opportunity now exists for companies to invest very tax-efficiently over the next two years with backing from the Chancellor

The Chancellor’s recent Budget Day announcement of a new style of capital allowance which will allow companies to reduce their taxable profits by 130 percent of the cost of new equipment has attracted a lot of interest.

But it’s also raised a number of questions in relation to how it works and, importantly, which businesses – practices – can take advantage of it.

The super-deduction defined

Very simply, the “super-deduction” is a new temporary allowance which gives a greater and faster level of tax relief on qualifying expenditure incurred in the two-year period between 1 April 2021 and 31 March 2023. For most expenditure on plant and machinery, it works by treating the company as if it had spent an extra 30 percent on the item and then allowing tax relief on the whole of that uplifted amount in calculating the tax bill for the year of expenditure. So, with a 19 percent tax rate, the super-deduction is designed to reduce a company’s tax bill by some 24.7 percent of the actual cost of the qualifying item(s).

But the allowance isn’t available to all businesses; instead, it is only available to those which are subject to corporation tax – typically, limited companies. This means that veterinary practices operating as sole traders and partnerships will not be able to claim it, and nor will it be available to a company that is ceasing activity.

Only certain expenditure qualifies

The super-deduction only applies to items which are treated for tax purposes as plant and machinery. For many businesses, this is likely to cover most of their expenditure; simple examples of plant and machinery would include anything from a laptop to a consulting table. In contrast, a building or structure, or something intangible like a franchise, cannot be plant or machinery and will not be eligible for the super-deduction.

A special provision in the legislation means that any expenditure incurred as a result of a contract which was entered before 3 March 2021 – Budget Day – will be ineligible as the expenditure is treated as made before 1 April 2021 regardless of when payment was required.

Also, in relation to contracts entered on or after 3 March 2021, the general rule is that capital expenditure is treated as incurred as soon as there is an unconditional obligation to pay it – even if payment is not required until a later date. That said, there are also special rules on timing in relation to various circumstances.

Some items of plant or machinery are specifically excluded from eligibility for the super-deduction. Common examples include cars; all used and second-hand assets; and plant or machinery which is leased out by the purchasing company to another.

There are other types of plant and machinery that are not eligible, but which can benefit from accelerated allowances. More on this later.

The practical effect of the super-deduction

Before delving into the effects of the super-deduction, all businesses (whether limited companies, partnerships or sole traders) are already entitled to an annual investment allowance (AIA) which enables them to get tax relief on the whole of their qualifying expenditure for the year of purchase, up to an annual limit.

Until 31 December 2021, the AIA limit is £1 million, but is scheduled to reduce to an annual limit of just £200,000 from 1 January 2022. The higher limit means that a company spending £500,000 before 1 April 2021 on plant or machinery will (without the super-deduction) get a tax reduction at 19 percent on that amount – so £95,000. If that same level of expenditure was incurred after 31 March 2021 and qualified for the super-deduction, the tax reduction would instead be £500,000 x 130 percent which, at 19 percent, gives a tax reduction of £123,500 – so £28,500 more.

At higher levels of qualifying expenditure, the super-deduction will create a disproportionately greater benefit. If, for example, a company’s actual expenditure in a year is £5 million, the tax reduction (without the super-deduction) on that for the year of expenditure is £326,800 (being the maximum AIA limit of £1 million at 100 percent plus the balance of £4 million at 18 percent with both being relieved at the 19 percent tax rate). It would take another seven years to write off 75 percent of that £4 million. In contrast, a company incurring that same level of expenditure with the benefit of the super-deduction gets a tax reduction of £5 million x 130 percent, which at 19 percent, gives a tax reduction of £1,235,000. In this case, the super-deduction is creating an additional tax reduction of £908,200 in the year of expenditure.

So, it’s easy to see that the super-deduction both increases and accelerates the tax relief on qualifying expenditure and that the effect is more marked at higher levels of expenditure.

A separate special rate allowance may help

As already noted, some items of plant and machinery are not eligible for the super-deduction. This includes all items of capital expenditure which are treated as “special rate” assets. These assets include integral features of a building (items like heating, lighting and power systems and air conditioning), long life assets (items which have an expected useful life of at least 25 years – these tend to be big-ticket items), thermal insulation and solar panels.

Under the general capital allowance legislation, the annual writing down allowance on these items of plant or machinery is just 6 percent rather than the normal 18 percent meaning that these “special rate” assets are written off more slowly for tax purposes.

If a company incurs qualifying expenditure on these types of asset in the two-year period starting on 1 April 2021, they cannot qualify for the 30 percent value boost explained above, but the company is entitled to new “special rate allowance”. This provides tax relief for the year of expenditure on 50 percent of the actual cost instead of just 6 percent. Unlike the super-deduction, this does not increase the value of tax relief over the life of the asset, but it does significantly accelerate the relief.

So if, for example, the company spends £400,000 on such assets in a year, it would (ignoring the availability of any AIA – see above) normally take over 22 years to get tax relief on 75 percent of the cost. By allowing half of the cost to be written off in the year of expenditure, the special rate allowance provides tax relief on 75 percent of the cost in 11 years.

The end of the two-year period

During the Budget, the Chancellor also announced that the rate of corporation tax will increase from 19 percent to 25 percent with effect from 1 April 2023 – the day after the two-year super-deduction period ends. For companies with a 31 March 2023 year end, that creates no particular complication but for a company with a year end after that date it means that some of its profits are taxed at 19 percent and some are taxed at 25 percent. Without special provision, that would mean that a company with (say) a year end of 31 December 2023 which had incurred super-deduction expenditure before 1 April 2023 would get tax relief at 19 percent for three months and 25 percent for nine months on 130 percent of the cost. The super-deduction legislation prevents this with some slightly odd arithmetic, but it does produce the right answer – an effective tax saving of fractionally over the 24.7 percent rate referred to above.

If after 1 April 2023, a company would still be paying corporation tax at 19 percent because its annual profits did not exceed £50,000, it is possible that the super-deduction would not work so effectively for its accounting period which ended after 31 March 2023. That issue would not arise in its previous accounting period.

Super-deduction, the special rate allowance and tax losses

Another feature of the capital allowances regimes is that they can reduce a company’s taxable profits and can therefore either create or increase a loss for tax purposes.

Companies can normally carry back losses from one accounting period to the previous accounting period so that the profits of that previous period are reduced. This enables a repayment of Corporation Tax for the previous period. Because of the pandemic, the Chancellor has announced that losses arising in a company’s accounting period which ended between 1 April 2020 and 31 March 2022 can be carried back for two further years.

Such a loss carry-back could enable a company that had depressed profits to still receive early tax relief. It would, however, be important to consider the alternative of carrying the loss forward, particularly if that might result in tax relief at 25 percent instead of 19 percent.

Other things to consider

An important consequence of both the 130 percent super-deduction and the special rate allowance is that part of the tax reduction will be clawed back if the relevant asset is subsequently sold. This needs to be borne in mind if such a disposal is likely.

Unsurprisingly, there are specific anti-avoidance provisions to prevent abuse of these significantly more generous tax reliefs. These provisions typically target arrangements which include artificial (non-commercial) steps.

In summary

With the complexities set down in tax law, it’s not hard to see that it is essential for any practice operating as a company to take appropriate professional advice in advance to ensure that the super-deduction or the special rate allowance work as expected. The opportunity now exists for companies to invest very tax-efficiently over the next two years with backing from the Chancellor.

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