• The Annual Investment Allowance limit of £1m was due to end, but has been extended for a further 12 months
  • It is designed to incentivise businesses to invest in plant and machinery, by allowing them to offset the costs against their tax bills
  • Businesses are advised to look carefully at their financial positions before investing, and make sure they allow sufficient time to meet the 31 December 2021 deadline

The government recently announced that the increase to the Annual Investment Allowance (AIA) would be extended for a further 12 months. This means that businesses in many sectors will be able to offset investments in plant and machinery for their businesses of up to £1m against their taxable profits in 2021 – just as they have been able to in 2019 and 2020.

The background

The AIA was increased in 2019 in an attempt by ministers to incentivise investment by businesses in the UK’s major industrial sectors: this kind of spending, which is crucial for the UK’s productivity and future growth, had fallen sharply in 2017 and 2018 as a result of the economic slowdown, amid uncertainty over Brexit and international trade.

Chancellor Rishi Sunak’s decision to extend the £1m upper limit for a further year reflects the impact that the coronavirus pandemic has had on business investment in 2020.

Steve Watts, tax partner at accountancy firm BDO, says: “The AIA was originally introduced in the Finance Act 2008 to encourage investment in plant and machinery and to simplify the tax system for smaller businesses. The annual rate yo-yoed around a bit for a number of years until 2016, when it was said to be permanently retained at £200,000 per annum to provide certainty to businesses. Since then, we have had the increase for two years from January 2019 to £1m per annum – which was due to expire at the end of this year.”

Watts says that the increase in the limit has, to some extent, been a success in that it has encouraged businesses to invest more. “But certain investment decisions that had been planned for this year were not able to take place as a result of lockdown and the impact it has had on businesses,” he says.

As managing director of Lombard, Ian Isaac speaks to many businesses that have stalled investment decisions as a result of the pandemic. “Of course, we welcome the decision to extend the limit of £1m by another year,” he says. “Businesses have had to weigh a new and unique set of risks in 2020, and it’s only right that they are helped to invest again as the economy recovers.”

Questions of timing

Generally, the AIA applies to expenditure made by businesses on plant and machinery. “This could be expenditure on a new production machine or in relation to a business incurring expenditure on new premises, which includes plant and machinery within that building,” Watts says. “For example, if they incur expenditure on a lighting or heating system, that can qualify as plant and machinery – and be eligible for the AIA as well.”

Businesses that are thinking about taking advantage of the extension to the higher AIA limit should take note from the government’s web page that certain items, such as cars, are exempt from the allowance. They will also need to plan ahead. “If there is a long lead-in time for a piece of equipment then you might want to make sure of the timing of delivery of the equipment so that the expenditure is incurred in the year the higher AIA is available,” explains Watts.

Businesses may be tempted to delay their investments until there is more economic certainty, but that waiting may be an opportunity cost. It’s a question of balance

Ian Isaac
Managing director, Lombard

Another factor to take into account is that the increased allowance runs for the calendar year –

Another factor to take into account is that the increased allowance runs for the calendar year – from 1 January to 31 December. This can create issues for businesses that do not have a 31 December year end, he says.

“So if, for example, a company has a 30 June year end, then in the year to 30 June 2021, the company will have a full £1m AIA,” Watts explains. “Assuming then that the allowance reverts back to £200,000 on 1 January 2022, that company’s AIA for the year ended 30 June 2022 will be effectively calculated as six months at the current rate, which is £500,000, plus six months at £200,000 – so £600,000 overall in the year.”

However, he adds, the timing of the expenditure is still important: “That £500,000 is only available if the expenditure is incurred by 31 December 2021.”

Isaac adds: “Businesses may be tempted to delay their investments until there is more economic certainty, but they need to remember that waiting may be an opportunity cost. It’s a question of balance that is unique to every company.”

In the balance

Given the recent economic downturn and the challenges created by the pandemic, businesses should also ensure that they have sufficient profits to offset the AIA against. “There may be some businesses that have losses as a result of the recession and therefore the AIA may only increase tax losses in that period, rather than providing an intended cash-flow benefit,” Watts says.

“Businesses need to take a careful look at their financial positions before making a decision,” adds Isaac. “If in doubt, they can always seek external advice before committing to an investment. And, it’s worth remembering, £1m is only the upper limit. Businesses looking to invest less than that amount can also take advantage of the AIA.”

The economic outlook for 2021 is still very mixed, and businesses may be asking whether ministers might decide to prolong the higher AIA limit period beyond the start of 2022. There may be a case for it, but by no means is an extension certain. Watts says: “I think we will need to see what position the economy is in next year, with the impact of Brexit and as we come out of the pandemic, to see whether it might be extended again.”

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