Capital ideas required as allowances tax rules bite

THIS WAS A “Budget for making things, not making things up”, chancellor George Osborne proudly declared. He decried that “small businesses are the innocent victims of the credit crunch”, and said the government wished to encourage “manufacturers to invest in the latest machinery and technology”.

However, although there were measures to help the small manufacturers – such as the doubling of the short life asset scheme (see box) and the introduction of enterprise zones – these are secondary to changes coming into force next year.

Businesses must pay tax on capital assets over and above their allowances. However, from April 2012 these allowances will be reduced. The annual writing down allowance (WDA) will decrease from 20% to 18% and the annual investment allowance will go down from £100,000 to £25,000. It is up to advisers to help alleviate these losses.

And there will be losses. The reduction in the capital allowance rate is going to bring in £5.6bn for the Exchequer in its first four years, with £1.7bn estimated in 2015/16 alone. The reduction in capital allowance will generate £3.4bn in the same period, with £1bn estimated in 2015/16.

To put this in perspective, the much-vaunted reductions in corporation tax over the five years to 2015/16 will cost the Exchequer £4.2bn and reforms to controlled foreign companies legislation £2.3bn in the same period.

For smaller businesses, the reduction in the main and lower rate of corporation tax will be welcome. But even in this case, the reductions in the lower rate are far smaller than in the main rate. Indeed, current plans mean that there will be a three percentage points difference in the rates by 2015/16 compared with seven last year.

For most small businesses, this convergence will not matter, as long as their own relative rate decreases, even if it is by only a single percentage point. But manufacturers have a right to feel a weight on their shoulders. With the credit crunch making it more difficult to afford capital purchases, the sector has suffered more than most in the recession and will likely suffer even more overall from the coalition government’s reforms.

Cathy Corns, partner at Mercer & Hole, says many of her clients bring in profits of less than £300,000, while devoting up to £100,000 in capital expenditure a year – meaning they do not benefit much from the corporation tax reductions, while having their allowances wiped out by 75%.

So what can advisers do? Menzies partner Richard Godmon says he is already telling clients to bring forward their capital purchases to this tax year. But this is not possible for many businesses that still have cash flow problems.

The more common approach will be forensically looking at the accounting treatment of smaller capital items. There is nothing in tax legislation that defines plant and machinery, but case law seems to suggest that items with a useful life of less than two years can be declared under revenue and renewal.

Liam Henry, corporate tax manager at Hillier Hopkins, said that, whereas he had previously been happy to put spending through as capital, he would now allocate more time looking at what can be put through as revenue – which will mean a greater cost for the client.

This is a course that advisers to small manufacturers will have to follow, but the client will pay either way. And there is not much more that this beleaguered sector can take. Rather than making things, government measures have made things harder.