Willie Mackenzie explains the intricacies of capital
allowances and provides a few tips to guide you through the
maze.
A frequent question I hear from dentist clients is: What is the
most tax -efficient way of buying dental equipment? There is also
the separate question of whether it is better to lease or buy but
this will be the subject of a separate article. The answer to both
questions centres on the use of capital allowances which in
layman's terms means "tax allowable depreciation"
A capital allowance is a tax device for spreading the cost of an
item which is bought to last some years over its expected lifetime.
The tax law sets out what level of capital allowances can be
claimed for each broad category of asset. For instance, most dental
equipment will attract a capital allowance of 25 % of the balance
of the cost each year and together with a First Year Allowance
(FYA) of 40% this will result in tax relief on 90% of the
expenditure having been achieved by the end of year 6 (Example 1).
Compare this to a system where there are no FYA s and you can see
that the 90% level is achieved by the end of year 8 (Example 2).
The difference is that greater up-front relief is achieved by the
use of FYA s.
1. Timing
It does not matter at what stage during the accounts year you
buy the equipment you will get the full capital allowance due for
that year as long as your accounts have been drawn up for a 12
month period. So if you are considering an expensive purchase, buy
the asset just before the financial year-end and you will
accelerate the benefit of the capital allowance by 12 months.
Expenditure is deemed to be incurred on the date on which the
obligation to pay becomes unconditional - usually on delivery.
2. Manipulation - make use of
incentives
Most Chancellors like to use the capital allowance system to
encourage businesses to invest in modern technology. Small
businesses such as your dental practice claim a 50% capital
allowance in the year in which they buy most of types of equipment
- known as a First Year Allowance. Furthermore, enhanced capital
allowances (ECA s) are available for energy-saving investments,
allowing businesses to claim generous up-front tax reliefs. Cars
with low emissions of CO2 (up to 120 gm/km also qualify for a 100%
first year allowance if purchased new rather than second-hand) up
to 1 April 2008.
Enhanced Capital Allowances (ECA s)
What Expenditure Qualifies?
ECA s enable a business to claim 100% first year capital
allowances on their spending on qualifying plant and machinery.
There are three schemes available:
* energy saving plant and machinery
* low carbon dioxide emission cars
* water conservation plant machinery
Businesses - including dental practices - can write-off the
whole of the capital cost of investments in these technologies
against the taxable profits of the period during which they make
the investment. This can result in a significantly reduced tax bill
and hence deliver a positive impact on cash flow. The types of
equipment currently covered by ECA s will feature prominently in
any dental surgery and will include:
* compressed air equipment
* lighting
* refrigeration equipment and air conditioning
* toilets and taps
This list is not exhaustive but is merely illustrative of the
principal types of equipment included in this scheme.
The ECA scheme enables you to claim accelerated tax relief when
you buy energy saving equipment.
To qualify for ECA s the expenditure must be included on the
list of qualifying products set out on the HMRC website. If the
products are not on the approved list they do not qualify. You must
therefore ask your supplier if their product meets the required
technical specification.
3. FYA s - Extra 10%
In his last Budget, the Chancellor increased FYA s to 50% from 6
April 2006 for small businesses- but only for one year. After.5
April 2007, they will revert to 40%. Accordingly, there is a
marginal advantage in spending your capital budget before the end
of this tax year.
4. Computers and IT Equipment - Why not
write them off?
Up until quite recently dentists could get 100% first year
allowances (FYA) on IT equipment, including computers but now 100%
tax relief has all gone - or has it? As most dentists will be aware
the cost of computers and IT equipment has continued to fall in
real terms and what used to cost several thousand pounds a few
years ago, now costs hundreds of pounds. The simplest way of
getting tax relief is to write-off the cost of purchase in the year
of acquisition. With technology moving so fast nowadays it is
increasingly more difficult to justify capitalising expenditure -
i.e. putting it on the balance sheet and not writing-off the
expenditure in the year of acquisition.
Remember, that one of the main justifications for capitalising
expenditure is that one must be able to demonstrate that such
expenditure is "for the enduring benefit of the trade". What is
enduring about equipment that is only likely to last a year or two
before becoming obsolete? You might even want to introduce a
capitalisation policy such that expenditure under a certain amount
- say £500 is automatically written off in the accounts. But
remember - you have to be consistent - don't chop and change and do
discuss this with your accountant.
A New Surgery
The general rule is that capital allowances must be claimed. If
there is no claim there are no capital allowances due. In simple
parlance, this means that if you don't ask for it you won't get
it!
The expenditure on getting a new surgery into shape will more
often than not cost tens of thousands of pounds so a lot of money
is at stake. Not all expenditure on a new surgery will qualify for
capital allowances. In broad terms the expenditure must fit the
definition of plant and machinery which is very wide. In practice,
the biggest difficulty is differentiating between expenditure that
attaches to a building and hence is not allowable and that which
does not. That said, there is certain expenditure which at first
sight would appear not to qualify, which in fact does qualify. This
makes the task of the accountant notoriously difficult. It is not
simply a question of claiming allowances on all the expenditure as
this will inevitably attract the unwanted attention of the taxman.
Disallowing unwanted claims for capital allowances, is one his
favourite pastimes and could have other nasty side-effects such as
a tax enquiry.
Almost invariably, the expenditure on a new surgery will include
a mix of non-qualifying expenditure, expenditure which attracts
allowances of 25% and expenditure which qualifies for 100%
allowances. A dentist's investment in new equipment is possibly the
largest single investment that he or she will make other than the
acquisition of a practice. In fact sometimes the two go together.
It is worth some upfront planning and can help to enhance a funding
proposal to your bank.
Leasing
No article on capital allowances would be complete without some
reference to leasing. When an asset is purchased under a hire
purchase or lease purchase agreement, the expenditure is regarded
as incurred as soon as the asset comes into use - even though the
asset is not strictly owned until the option to purchase payment is
made - usually the final instalment. The hire purchase charges are
not part of the cost of the asset but can be claimed separately as
a business expense over the life of the agreement. However for
finance leases, although the assets are treated as owned by the
leasee for accounting purposes they do in law belong to the lessor
(usually the finance house) and it will be they that receive the
capital allowances. However, there has been a recent change in the
law to the effect that with the exception of lease agreements of
less than 5 years , the tax treatment will follow the accounting
treatment.