Annual Investment Allowance

[Bill the Bass]

I’m trying to do a bit of planning going forward, does anyone have a worked example of how AIA works, I want to be a bit more informed before I discuss with the accountant.

 

[Steevo]

@farmerdan7618 is your man.

 

[David.]

Spend what you like and it knocks out your income tax bill.
Unlike conventional depreciation, upon which you pay income tax.
Is about how it seems to work in practice.

 

[farmerdan7618]

Here's a worked example of AIA on a tractor purchased with a trade in.

New tractor 100k
Trade in 40k
Equals 60k to change.

60k is the AIA to go against profit for tax purposes.

To go from profit in the accounts, to profit for tax.

Accounts profit 50k
Add back depreciation (on everything, not just the tractor) 50k
Deduct AIA 60k
Equals 40k profit for tax.

This is a simplified example, and there are limits to the AIA that can be claimed in a year which is currently 1m and other factors that affect it, but will get close in many cases.

 

[Farmertom1988]

Here's a worked example of AIA on a tractor purchased with a trade in.

New tractor 100k
Trade in 40k
Equals 60k to change.

60k is the AIA to go against profit for tax purposes.

To go from profit in the accounts, to profit for tax.

Accounts profit 50k
Add back depreciation (on everything, not just the tractor) 50k
Deduct AIA 60k
Equals 40k profit for tax.

This is a simplified example, and there are limits to the AIA that can be claimed in a year which is currently 1m and other factors that affect it, but will get close in many cases.

Apologies to hijack the thread slightly, but can AIA be claimed on second hand plant and machinery purchases?

 

[farmerdan7618]

Apologies to hijack the thread slightly, but can AIA be claimed on second hand plant and machinery purchases?

Yes, AIA can in the vast majority of cases.
Super deduction is slightly different, and only on brand new.

 

[curlietailz]

I cannot understand why you add depreciation back
Surely depreciation is a loss ( in value) so how can you pay tax on your loss

can someone explain the logic in simple terms

 

[David.]

To stop you buying something, immediately depreciating it to nothing in your books, and claiming that you have therefore made no taxable profit.
It encourages you to depreciate items at a more realistic rate over the working life.
No need to be angry, that is what AIA is for.

 

[Steevo]

I cannot understand why you add depreciation back
Surely depreciation is a loss ( in value) so how can you pay tax on your loss

can someone explain the logic in simple terms

Depreciation is an accounting tem, not a tax term.

You do claim that "loss" as tax relief instead. Tax relief is what the government offers businesses on the value of the (depreciating) assets they purchase. If you tried to claim "depreciation" on top you'd effectively be double claiming.

 

[curlietailz]

To stop you buying something, immediately depreciating it to nothing in your books, and claiming that you have therefore made no taxable profit.

that angry emoji was directed at the system rather than you. Lol

 

[farmerdan7618]

I cannot understand why you add depreciation back
Surely depreciation is a loss ( in value) so how can you pay tax on your loss

can someone explain the logic in simple terms

Depreciation is made up by people running businesses and their accountants, it is therefore open to abuse.

To counteract this HMRC give capital allowances on their terms.

You will always get tax relief on the amount you lose on a machine over it's life, the timing is different though.

 

[snarling bee]

Once you have claimed tax relief in terms of allowance, then that machine is not depreciated again, so all you are doing is saving tax in the year of purchase, but paying more tax in subsequent years as that item cannot be depreciated.

 

[Bramble]

So what’s the point in showing depreciation in the accounts?

It doesn’t really tell you anything, except a level of historical capital expenditure. It’s taken off profit in your P&L and added back on for your tax calculation

 

[e3120]

So what’s the point in showing depreciation in the accounts?

It doesn’t really tell you anything, except a level of historical capital expenditure. It’s taken off profit in your P&L and added back on for your tax calculation

It's supposed to a truer view of real profitability. In theory if you cashed out there wouldn't be any unexpected profit or loss if everything was depreciated accurately. Different story with the taxman when aia has a sting in its tail.

 

[texelburger]

Once you have claimed tax relief in terms of allowance, then that machine is not depreciated again, so all you are doing is saving tax in the year of purchase, but paying more tax in subsequent years as that item cannot be depreciated.

Exactly,so AIA is a useful tool when you are having a good trading year.

 

[farmerm]

Once you have claimed tax relief in terms of allowance, then that machine is not depreciated again, so all you are doing is saving tax in the year of purchase, but paying more tax in subsequent years as that item cannot be depreciated.

But if depreciation is added back before tax is calculated then how does using depreciation rather than AIA have any impact on tax owed in either the purchase year or subsequent years? If I buy seed, fertiliser or plough parts I can see directly how that affects the taxable profit... I cant figure out where accounting for capital purchases using depreciation rather than claiming AIA have any bearing our our taxable profits, either in the year of purchase or any subsequent year?

 

[tepapa]

Depreciation is a made up figure but hopefully shows more realistic value to your assets/business.
If you made £30k income but the value of your tractor has lost £10k (bloody deutz ) then your only really £20k better off than you where. Since you made up the depreciation figure (20%) it may not truly reflect the actual real value loss for that year. Tax man can't really keep track of things depreciating or even appreciating every year so gives you capital allowances because it knows that in general things will lose value. Government then use this as a tool to stimulate economic growth my changing the allowance claimable in a year such as the new 130% allowance this tax year as it knows it'll get it's tax back if you sell up whilst it still has value.

 

[curlietailz]

But then IF you have depreciated too aggressively and your tractor is worth more when you do sell it.... you pay tax AGAIN

ie buy a tractor for 120k
Depreciate over 10 years by 10k/year
So in year 10 it’s book value is £20k

you get AIA on the £120 k in year 1x but have to pay tax on the £10k/year in years 1-10

then if it was a John Deere 7810 ( for example) it’s actually worth 40k when you sell it..... you pay tax on the appreciation of £30k

So you pay tax on the depreciation and again on the appreciation ????

shouldn’t the depreciation figure therefore actually be only£5k/year in that case.

 

[Steevo]

But then IF you have depreciated too aggressively and your tractor is worth more when you do sell it.... you pay tax AGAIN

ie buy a tractor for 120k
Depreciate over 10 years by 10k/year
So in year 10 it’s book value is £20k

you get AIA on the £120 k in year 1x but have to pay tax on the £10k/year in years 1-10

then if it was a John Deere 7810 ( for example) it’s actually worth 40k when you sell it..... you pay tax on the appreciation of £30k

So you pay tax on the depreciation and again on the appreciation ????

shouldn’t the depreciation figure therefore actually be only£5k/year in that case.

You claimed £120k in AIA. But when you sell it then it’s worth £40k so you pay back the AIA tax relief you recovered earlier.

Good thing I guess is money you pay back is potentially worth less due to inflation.

Downside is if you were paying 20% tax in Y1 and thus claimed tax relief at 20% but moved up to 40% tax by Y10 it rather stings paying higher rate back on the “profit”.

 

[farmerm]

If one buys a bolt for £1 it reduces ones profits by £1 which reduces ones tax bill by 20p (assuming 20% rate). I end up with a bolt and 20p more in my pocket so buying the bolt really only costs me 80p? Now if one purchases a £50k tractor and ones accountant claims AIA relief on the real cost is £50K less the 20% tax saving of £10k. Purchase cost £40k But if ones accountant doesn’t claim AIA on the purchase in the year of purchase that £50k purchase really is the full £50k? There is no £10k in tax savings to be found spread out over the life of the machine if you accountant takes a depreciation approach?