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Super deduction – super benefits?

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In the recent budget there was an eye-catching ‘super deduction’ announcement. This tax break will allow companies who invest in qualifying capital expenditure between 1 April 2021 and 31 March 2023 to claim a super-deduction against their corporation tax profits by way of an enhanced capital allowance of 130% on most new items of plant and machinery. For example, companies who spend £10m on new equipment, will be able to reduce their taxable profits by £13m, an immediate tax cash benefit of £2.47m. This certainly came as good news and balanced out the less welcome announcement of a rise in corporation tax to 25% from April 2023. Of course, the £2.47m roughly equates to 25% tax relief two years ahead of the rate increasing to 25%; deliberate or a coincidence?

Currently, companies investing £10m are eligible for the 100% Annual Investment Allowance (AIA) on the first £1m with the remaining £9m subject to the 18% Writing down allowance (WDA). At 19% tax rate, this equates to a reduced corporation tax liability of £497,800. As stated above, from this April, the same £10m will reduce the same corporation tax liability by a whooping £2.47m, a year one benefit of almost £2m!

This measure is therefore not surprisingly aimed at stimulating business investment at a time in which growth is desperately needed. The UK economy shrank by nearly 10% in 2020; the greatest contraction since 1709. However, the Office for Budget Responsibility (OBR) has stated that the UK will recover six months faster than was previously predicted. The Treasury expects the policy to cost nearly £25bn over 2021/22 and 2022/23, implying eligible capital spending of around £100bn. All this is good news for companies and manufacturers who are in a position to invest.
Let’s also not forget the other related Budget announcement – the new 50% First Year Allowance (FYA) for new qualifying special rate assets such as integral features in commercial buildings, items with a long life etc. Currently it is only possible to claim WDA of 6%, so this announcement also represents a significant cash flow benefit for companies investing in the next two-year window.

Who is eligible?

All SMEs who pay corporation tax are eligible for these tax breaks. Those excluded are partnerships such as lawyers or accountants and sole traders and any other businesses who do not pay corporation tax. A company’s size does not matter but companies who will benefit most will be large organisations who invest heavily in warehouse equipment, plant and machinery for example, Amazon.

HMRC have now confirmed that the super deduction is available to assets acquired using hire purchase finance provided that the contract provides for the ownership of the asset to pass to the hirer on exercise of an option to purchase and that the asset is capitalised in the hirer’s accounts. However, assets acquired under finance lease type arrangements will continue to be ineligible for capital allowances, including the super deduction.

Remember however, the AIA is extended at the £1m level until the end of 2021, which should offer some relief for the purchase of second-hand assets (not new) and leased assets.

Finally, it is worth mentioning, new rules bring new complexities not least when assets over which the super deduction was claimed in the year the assets were bought are finally sold. In such cases, the disposal proceeds will be taxed as trading income and not deducted from the capital allowances pool. This could present a significant unwinding and nasty claw back in subsequent years.

The farming and construction sectors amongst others, will be welcoming this boost. Also, the tax break will provide manufacturers with an incentive to renew their equipment with the promise of what should be sustained demand following a period of slower investment held back by the COVID-19 pandemic.

Too good to be true?

As with every positive measure to come out of a budget, there are downsides to the super-deduction scheme. The fact that it is only applicable to ‘qualifying plant and machinery’ i.e., hardware, seems to be an oversight in terms of technology as we are in an increasing digital age with software becoming as important as hardware in every sector. In addition, many companies who have been hit hard by the pandemic in 2020 will struggle to make enough profits to benefit from the tax allowance. Manufacturers producing equipment for the airline industry, for example, have been some of the hardest hit due to travel restrictions.

Further details have been released with respect to how assets benefiting from the super deduction will be taxed when they are sold. We already knew that the disposal proceeds arising from the sale of assets which had benefited from the super deduction announced in the 3 March budget would be taxed as business income and not deducted from the capital allowances pool (where in some cases deferral would have been possible) but it has now been announced that the disposal value will be uplifted by 30% to take account of the fact that the relief on the original expenditure was greater than 100%.

So, whilst the 130% allowance may, at first glance, look a very attractive proposition, the impact of the 30% uplift to disposal proceeds should also be taken in place and coupled with the fact that corporation tax rates are increasing to 25% in two years’ time. It is possible that where assets are held for a relatively short period of time before sale and the asset in question holds its value, companies might be worse off claiming the super deduction as the 30% “bonus uplift” will be clawed back and not just at the 19% rate enjoyed on purchase but at the higher rate in force from 2023 of 25%. My advice is buyers beware and, like all things tax driven, make business decisions for solid commercial reasons and do not be tempted by the tax tail wagging the dog.

How and when to forge ahead

What might seem an exciting proposal at first needs to be carefully considered as the size of investment, current investment plans and the type of assets being purchased are all important factors. To take advantage of the super-deduction, companies will need to bring forward spending to ensure that they benefit. The sharp rise in corporation tax in 2023 could effectively cancel out any rewards from the super deduction, particularly for investments at the lower end of the scale. Essentially, corporates with an investment plan of £1m or less per annum, would be better off sticking to their original plans or risk losing any profits when the 25% corporation tax comes into effect.

Similarly, a sole trader or partnership might consider becoming a limited company in order to benefit from the super deduction. Again, the two-year reprieve before the rise in corporation tax is not long and might nullify any fiscal advantages of becoming a limited company. Partnerships and sole traders can still benefit from the new three-year loss relief carry back scheme.

Next steps

For any company owners considering revising their investment plans in the light of the super-deduction announcement, it is, of course, essential to obtain professional advice. It is important to look at more than simply the tax break available and to analyse financial plans over the next few years to see if this is a viable option. If this affects you and your company, please don’t hesitate to contact us for support and advice.

Mark Pashley corporate and business tax partner

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