Annual investment allowance

    Annual investment allowance

    Accountants use the expression “deferred rust” for expenditure on machinery intended to reduce tax.  We look at the real saving and some of the factors to consider.

    The Annual Investment Allowance (AIA) currently stands at £250,000.  This means that the whole value of any purchase of plant and machinery up to this amount can be set against tax.  For a 40% marginal tax rate payer this means that on a £100,000 purchase £40,000 is paid for by a reduction in tax. 

    However, the calculation does not stop there. A £100,000 tractor is likely to lose value at about 18% per year before inflation so if sold in say eight year’s time the sale value is likely to be about £24,000 (with the replacement cost at about £117,000).  The £24,000 trade-in is taxable also at the marginal rate giving rise to a tax liability of £9,600.

    Without the AIA, and for expenditure now in excess of the £250,000, the investment is subject to an annual writing down allowance of 18%.  This means that instead of having the option to put the entire cost against tax in each year a reducing element can be taken in each year. 
    The accelerated capital allowance actually makes no difference to the overall cash outflow but does provide a cashflow advantage – which with interest rates as they are now is fairly minimal.  The same is true of the writing down allowance.

    There are other factors to consider such as changing marginal tax rate but with profit averaging this is less likely to be important for farmers although still an issue if the overall rate changed.

    In conclusion, it is much more important to make the correct investment decision rather than making tax based decisions.  If machinery can be retained an additional year without major break down a substantial saving can be made.  Also consider that the timing of implementation of a new system can make as much of a difference to cost as the change of system itself.

    The data attached are applied to a tractor purchase of £100,000 kept for 8 years depreciating at a typical rate of 18% before inflation.  In both examples, the cash outflow taking into account tax is £45,600 but the timing differs as shown in this graph.