The annual investment allowance (AIA) was increased from its usual level of £200,000 to £1 million for the two-year period from 1 January 2019 to 31 December 2020. As this period draws to a close, it may be prudent to review planned capital expenditure, particularly where this has been put on hold due to the Covid-19 pandemic. The AIA will revert to £200,000 from 6 April 2021.

What is the AIA?

The AIA is a capital allowance which provides for 100% relief for qualifying expenditure up to the available AIA in the period in which the expenditure was incurred. However, the allowance does not have to be claimed – writing down allowances can be claimed instead for some or all of the expenditure. Once the AIA has been used, relief for any further expenditure is given in the form of writing down allowances.

Incur expenditure in 2020 rather than 2021

The AIA for an accounting period depends on when the period falls. If the period falls wholly within the two-year period from 1 January 2019 to 31 December 2021, the allowance is £1 million. This is proportionately reduced where the accounting period is less than 12 months.

So, where a company prepares accounts to 31 December each year, it will have an AIA of £1 million for the year to 31 December 2020 and an AIA of £200,000 for the year 31 December 2021.

Consequently, if the company is planning to incur qualifying capital expenditure of more than £200,000, it would be beneficial from a tax perspective to incur the expenditure in 2020 rather than 2021 to maximise the immediate relief against profits.

Periods spanning 31 December 2020

Where the accounting period spans 31 December 2020, transitional rules apply to work out the AIA for the period. This is found by applying the formula:

(x/12 x £1,000,000) + (y/12 x £200,000)

Where:

  • x is the number of months in the accounting period prior to 1 January 2021; and
  • y is the number of months in the accounting period after 31 December 2020.

Therefore, if a company prepares its accounts for the year to 31 March 2021, the AIA for that year is £800,000 ((9/12 x £1,000,000) + (3/12 x £200,000)).

However, the transitional rules have a sting in the tail – a cap applies to expenditure incurred in that part of the accounting period falling on or after 1 January 2021.

The cap is found by applying the formula:

y/12 x £200,000

Where:

  • y is the number of months in the accounting period after 31 December 2020.

This means that where the accounting period is the year to 31 March 2021, the cap is £50,000 (3/12 x £200,000). The cap operates to limit the AIA for expenditure incurred in the period 1 January 2021 to 31 March 2021 to £50,000, even if the expenditure for the year is with the AIA of £800,000.

Thus, to prevent the cap biting and to obtain maximum benefit from the AIA for the year, the bulk of the expenditure should be incurred in 2020 rather than 2021. This can catch the unwary.

Partner note: CAA 2001, ss. 51A – 51N

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