Week 6 Lectorial 1 - Self Employment - Losses & Capital Allowances PDF

Principles of Presentation by Joanna Hill Senior Lecturer – Taxation Accounting and Finance Week 6 Lectorial 1 – Self October employment – 2024 Capital allowances and losses Overview 1. Capit...

Principles of Presentation by Joanna Hill Senior Lecturer – Taxation Accounting and Finance Week 6 Lectorial 1 – Self October employment – 2024 Capital allowances and losses Overview 1. Capital allowances 2. Losses  Things covered in the textbook that are not relevant All topics are relevant this week but as usual ignore Scotland! Capital allowances  Technical content today General principles Qualifying expenditure Plant and machinery Main pool and special rate pool Writing down allowance Annual investment allowance First year allowance Balancing allowances and charges Non-pooled assets Cessation of trade Structures and buildings Miscellaneous capital allowances  General principles If a GAAP election has been made, capital expenditure is not deductible when calculating trading profits for tax purposes Depreciation charges shown in the accounts are also not deductible Instead, standardised depreciation allowances known as "capital allowances" are available in respect of certain categories of capital expenditure There is generally one capital allowances computation per period of account Capital allowances are deducted when calculating the trading profit for tax purposes  Qualifying expenditure The main categories of capital expenditure which qualify for capital allowances are: ▪ Plant and machinery ▪ Patent rights ▪ Know-how ▪ Research and development In practice, plant and machinery is by far the most important category  Plant and machinery Plant and machinery is not defined by statute It has been left mainly to case law to decide whether or not an item should qualify as plant and machinery General definition of plant and machinery: "apparatus … used by a businessman for carrying on his business … all goods and chattels, fixed or moveable … which he keeps for permanent employment in his business" (Yarmouth v France (1887)) Machinery of all types, motor vehicles, office furniture and equipment all qualify as plant and machinery  Fixtures to buildings Do fixtures to buildings qualify as plant and machinery? As a general rule: - if an item fulfils an active function in carrying on the business, it will be treated as plant (e.g. display lighting) - if an item performs only a passive function and is just part of the setting in which the business is carried on, it will not qualify as plant (e.g. a garage forecourt canopy) Expenditure qualifying as plant and machinery by statute ▪ Expenditure on thermal insulation ▪ Expenditure on personal security assets ▪ Expenditure on certain "integral features" of a building or structure ▪ Expenditure on computer software ▪ Expenditure on building alterations required for the installation of plant and machinery Some of these types of expenditure would normally be excluded by the "active function" test but this is over- ruled by statute. Main pool and special rate pool Generally, plant and machinery is pooled together in the "main pool" and capital allowances are calculated on the pool balance But a "special rate" pool is used for certain items such as integral features of a building (e.g. lifts and escalators) In general, cars with emissions of 50g/km or less are allocated to the main pool, but cars with emissions exceeding 50g/km are allocated to the special rate pool  Writing down allowance For each pool: the cost of any plant and machinery acquired during the period (and on which FYA or AIA are not claimed) is added to the pool any plant and machinery disposed of during the period is deducted from the pool for disposals, the amount deducted is the lower of sale proceeds and original cost writing down allowance (WDA) may then be claimed on the remaining balance in the pool  Rates of WDA WDA in the main pool is calculated at the rate of 18% per annum WDA in the special rate pool is calculated at the rate of 6% per annum WDA is scaled up or down if the length of the chargeable period is more or less than 12 months WDA is not restricted by the length of time an asset has been held during the period  Example – Main pool & SRP A business has a main pool with a current written down value of £25,000. It sells a machine for £10,000 (Original cost £20,000). The business also has a special rate pool of £35,000. The accounting period is 9 months long What are the capital allowances that can be claimed?  Answer – Main pool & SRP *9 months! Main pool SRP Total WDV b/f 25,000 35,000 60,000 Disposal (10,000) (10,000) Subtotal 15,000 35,000 50,000 WDA’s (*9/12) WDA @ 18% (2,025) (2,025) WDA @ 6% (1,575)  Small pools If the balance in the main pool or the special rate pool before claiming WDA is £1,000 or less, the business may claim a WDA of any amount up to the pool balance.  Annual investment allowance The first £1,000,000 per annum of expenditure on plant and machinery (other than cars) qualifies for annual investment allowance (AIA) of 100% If qualifying expenditure exceeds the AIA maximum, the expenditure beyond the maximum enters the appropriate pool and is eligible for WDA The AIA maximum is increased or reduced proportionately for periods of more or less than 12 months in duration A business may allocate the AIA between items of expenditure in any way it chooses normally special rate pool first  First year allowance A first year allowance (FYA) of 100% is available in relation to expenditure on unused: ▪ Zero emission motor cars (i.e. with emissions which cannot exceed 0g/km) (before 1 April 2025) ▪ machinery for use in the refueling of vehicles with natural gas, biofuel or hydrogen (before 1 April 2025) ▪ charging points for electric vehicles (before 6 April 2025) ▪ Zero emissions goods vehicles (before 6 April 2025)  Balancing allowances and charges If the disposal value of the plant disposed of during a period is more than the balance of expenditure in the pool, a balancing charge arises equal to the excess A balancing charge is a negative capital allowance and is added to trading profits The balance of the pool is then set to zero Balancing allowances or charges will also be required if a business ceases trading or if a non-pooled asset is disposed of (see next slide)  Non-pooled assets Certain assets are not brought into the main pool or the special rate pool. Instead, each such asset is treated separately for capital allowances purposes and has its own "single asset pool". There are two main categories of "non- pooled" assets. These are: ▪ assets with some private use ▪ short-life assets  Assets with private use If an asset is used by the trader partly for business and partly for private purposes, it must be dealt with on an individual basis Capital allowances are calculated as usual and are deducted in full when calculating the WDV of the asset But the trader may claim only the business proportion of these allowances  Short-life assets An item of plant and machinery (other than a motor car) which would normally join the main pool may be "de-pooled" and dealt with on an individual basis WDA is available as normal If the asset is disposed of within eight years, a balancing allowance will be given or a balancing charge will be made If the asset is not sold within eight years, its written down value is transferred to the main pool  Example on how to calculate Allocate to SRP first as slower rate of allowance Restricted to 50% but calculated as normal to reduce the value of the asset  Cessation of trade When a business ceases trading, plant and machinery capital allowances for the final chargeable period are computed as follows: ▪ Any additions in the final period are added to the pools as usual ▪ No AIA, FYA or WDA is given in the final period ▪ The disposal value of each pool (including single asset pools) is subtracted from the balance of unrelieved expenditure, generating balancing allowances or balancing charges  Structures and buildings SBAs may be claimed in relation to the construction cost of new commercial structures and buildings used for trade purposes. ▪ SBAs are given at 3% p.a. on cost ▪ Land costs and dwellings do not qualify. ▪ SBAs begin when an eligible structure or building is first brought into qualifying use. ▪ SBAs at 3% cease after 33 and one-third years (400 months) or when the structure or building is demolished or is brought into residential use. ▪ If an eligible structure or building is sold, the buyer takes over any remaining SBAs to which the seller would have been entitled.  Miscellaneous capital allowances Capital allowances are available in relation to certain other categories of capital expenditure including: ▪ Patent rights ▪ Know-how ▪ Research and development  Miscellaneous capital allowances Patent rights purchased for trade purposes are pooled and attract a WDA of 25% per annum “Know-how” is defined as industrial information and techniques of use in either: −manufacturing or processing −the working of mineral deposits −agricultural, fishing or forestry operations Expenditure on know-how is pooled and attracts a WDA of 25% per annum  Miscellaneous capital allowances Research and development. Capital expenditure on research and development which is related to a trade attracts a first year allowance of 100%. Losses  Technical content today Trading loss reliefs Carry-forward trade loss relief Capital allowances Trade loss relief against total income Early trade losses relief Terminal trade loss relief Post-cessation trade relief Transfer of a business to a company Losses on shares in unlisted trading companies Limit on income tax reliefs  Trading losses If a self-employed person makes a trading loss in the basis period for a tax year then: ▪ Trading income for that tax year is set to £nil ▪ Tax relief may be claimed in relation to the trading loss ▪ Several forms of loss relief are available ▪ Each relief involves offsetting the trading loss against the taxpayer's other income or gains  Trading loss reliefs Income Tax Act 2007 provides the following tax reliefs in relation to a trading loss: ▪ Carry forward trade loss relief ▪ Trade loss relief against total income ▪ Early trade losses relief ▪ Terminal trade loss relief  Carry-forward trade loss relief A trading loss may be carried forward and set against the first available profits of the same trade The unrelieved loss can be carried forward without time limit but relief must be given against the first available trading profits arising in the future Relief is given only against trading profits arising from the same trade  Capital allowances Capital allowances are included automatically in the calculation of a trading loss It is possible to claim less than maximum capital allowances in order to adjust the amount of a trading loss Unclaimed capital allowances are not lost, since higher pool balances are carried forward than would otherwise have been the case and this results in higher capital allowances in future years  Trade loss relief against total income A trading loss incurred during the basis period for a tax year may be relieved against the taxpayer’s total income of that tax year and/or the previous tax year The relief may be claimed for one of the available years, for both years, or for neither Partial claims are not possible Any loss not relieved against total income may be carried forward to be set against future This reliefprofits from is subject the same to a restriction ontrade the total amount of certain reliefs that may be claimed in a tax year (see final slide)  Time limit A claim to set a trading loss against total income must be made by 31 January in the second tax year following the tax year in which the loss was incurred For 2024-25 this would be 31 January 2027  Personal allowances Trading loss relief is set against total income before personal allowances are deducted Personal allowances can be used only in the tax year to which they relate But unrelieved trading losses can be carried forward and set against future trading profits If total income is small, trading loss relief against total income may not be worthwhile, since the income would in any case be covered by the personal  Relieving trade losses against capital gains If a claim is made to set a trading loss against total income for a tax year, any unrelieved part of the loss may then be set against any capital gains of that year Trading losses relieved against capital gains are treated as if they were capital losses of the year concerned  Early trade losses relief Losses incurred in the early years of trade may (as usual) be carried forward against future trading profits or set against total income In addition, trading losses incurred in the first four tax years may be carried back against total income of the three preceding tax years (earliest years first) A claim for early trade losses relief applies to all of the three years prior to the loss-making year This A relief is subject to a restriction on the total amount of loss incurred in an overlap period is treated certain reliefs that may be claimed in a tax year (see final as a loss of the earlier tax year only slide)  Time limit A claim for early trade losses relief must be made by 31 January in the second tax year following the tax year in which the loss was incurred For 2024-25 this would be 31 January 2027  Non-active traders A "non-active trader" is a person who carries on a trade but is not personally engaged in the trade for at least 10 hours per week The amount of "sideways" loss relief that may be claimed by a non-active trader in relation to a trading loss is limited to £25,000 This limit applies to the total amount of: −trade loss relief against total income −early trade losses relief −relief for trade losses against capital  Terminal trade loss relief A trading loss incurred in the last 12 months of trading can be set against the trading profits of the tax year in which the cessation occurs and the three previous tax years (later years first) To calculate the terminal loss, add together: a) The trading loss incurred from 6 April to the date of cessation b) The trading loss incurred from 12 months before the date of cessation to following 5 April If either (a) or (b) is a profit, this counts as zero  Post-cessation trade relief Certain categories of unrelieved post- cessation expenses may be set against the taxpayer’s total income of the tax year in which the expenses occur. These include: ▪ the costs of remedying defective work done while the business was operating ▪ bad debts which were not provided for in the accounts of the business  Transfer of a business to a company If a trader incorporates his or her business, unrelieved trading losses may be carried forward and set against the first available income received by the trader from the company concerned, provided that: ▪ the business is transferred wholly or mainly in exchange for shares in the company ▪ the vendor of the business continues to hold those shares ▪ the company continues to operate the transferred trade.  Losses on shares in unlisted trading companies A taxpayer who subscribes for newly-issued shares in certain unlisted trading companies and incurs a capital loss on the disposal of those shares may claim that this loss should be set against his or her total income as if it were a trading loss. This tax relief is generally available only if the trading company concerned is of a type which would qualify for the purposes of the Enterprise Investment Scheme.  Limit on income tax reliefs The aggregate amount of certain specified tax reliefs which may be deducted from total income in a tax year cannot exceed the greater of £50,000 and 25% of the taxpayer's income. The main loss reliefs to which ▪ tradethis limit loss applies relief are: against total income ▪ early trade losses relief ▪ post-cessation trade relief ▪ relief for losses on shares in unlisted trading companies  References Melville (2024) Taxation Finance Act 2024. 30th ed. Harlow: Pearson Education Limited.  Thank you! Any questions