It is fairly well known that when the accounts for the farm are prepared, the cost of any plant, cars, vans, buildings or other fixed assets purchased is not deducted directly from turnover to arrive at the profit for the year. Instead, in the accounts, a deduction for ‘depreciation’ is given based on the expected useful life of the asset.
The rate at which assets can be depreciated is subject to discretion and can potentially be exaggerated to mask or inflate profits. That is why for tax, a different, standardized mechanism – “capital allowances” – is used to give tax relief for expenditure on fixed assets.
Conceptually, the fundamental idea behind capital allowances is simple. Depreciation included within the accounts is disallowed (or ‘added back’) when calculating the profits subject to tax. Relief is then given separately for expenditure on fixed assets.
However, in practice capital allowances can be complex. There are multiple timing considerations which can greatly impact on the rate at which tax relief is given. The system has become more complex over the years, with many additional types of allowances being added, with older forms of allowance (for example, Industrial Buildings Allowance and Business Premises Renovation Allowance) being phased out.
Farming is a very plant intensive industry. Depending on the level of plant and machinery investment in the year, it is often the case that for farms, the accounting and taxable profits are very different because of the difference between depreciation and capital allowances.
The Annual Investment Allowance (“AIA”) is one of the most important capital allowances. It provides 100% tax relief for the cost of an asset in the year of acquisition, subject to an overall maximum. The maximum is currently £1m, reverting to £200,000 from 1 January 2022.
In essence, it allows for a wide variety of assets to qualify for full tax relief in the year of acquisition. So, in years where there has been a good harvest, re-investing some of that profit into new plant and machinery before the end of the year is one of the best tools to reduce the tax liability whilst helping to ensure future prosperity.
As with much of tax generally, there are certain restrictions when it comes to claiming the AIA. Some of these include:
- Related businesses and group companies – these can cause one allowance to be shared across multiple businesses.
- Excluded assets – certain assets, such as cars, do not qualify for the relief.
- Assets acquired under HP agreements – a common issue with farming clients is that they acquire assets under a HP agreement but do not bring the asset into use before the end of the accounting period because of how harvest falls with reference to their accounting year. This restricts the amount on which AIA can be claimed on that asset in the year of purchase.
- Connected party acquisitions – assets purchased from a connected party, even at market value, do not qualify for AIA. This situation can arise where farming equipment is owned personally but sold to a connected contracting company.
- Timing of purchases in year of reversion / increase – in years where the allowance changes, one carefully needs to consider the overall maximum for the year and the ‘period maximum’ where the year-end straddles the change.
A relatively new development in capital allowances is the introduction of the ‘super-deduction’. This allowance gives tax relief equivalent to 130% of the cost of the qualifying expenditure. This allowance is only available to limited companies and there is a small two-year window in which to claim the allowance. For farms run as limited companies, this will be a welcome development, preferable to even the AIA. Once more, the super-deduction comes with its own restrictions, such as assets needing to be new/unused and conditions that restrict the availability of the allowance in the case of plant hire companies (including farming contracting companies that lease their plant and machinery to say a family partnership) and landlords of commercial buildings containing plant and machinery.
There is an abundance of case law concerning capital allowances, particularly as to what constitutes ‘plant and machinery’. One recent case of particular relevance to farming businesses is the case of Stephen May and Another vs HMRC, a recent case where the First Tier Tribunal ruled in favour of the taxpayer.
The background to this case is that the Capital Allowances Act 2001 excludes buildings and structures from qualifying as plant and machinery. However, that same legislation provides an exemption for ‘silos used for temporary storge’.
The appellant had erected a silo for the purposes of drying, conditioning and storing grain, however HMRC argued that it did not qualify for plant and machinery allowances on the basis it was a building, not plant and machinery. HMRC’s viewpoint that only a small proportion of the overall expenditure represented expenditure on qualifying plant, meaning no tax relief was given for the majority of the total construction cost.
The taxpayer was able to persuade the tribunal in part because of the sophisticated nature of the silo (it contained a complex system to dry and aerate the grain). It was also factored into the decision that storage of the grain for some 10 months of the year constituted ‘temporary storage’ (with the facility being cleaned for the remaining two months of the year ready for the next harvest).
Whilst this particular case is relatively useful as a precedent (some commentators originally cited the decision as potentially ‘opening the door’ for claims on other agricultural buildings, but in truth the usefulness of the decision as a precedent is far narrower in scope), it serves more to show that every capital allowances claim should always be assessed on its own merits, and by going back to the basic principles.
Following on from the above, another relatively new capital allowance worthy of specific mention is the ‘Structures and Buildings allowance’ (“SBA”). In the period of time between the abolition of Industrial Buildings Allowance and the introduction of the SBA in October 2018, it was a well-established principle that the fabric of a building or structure itself would not usually qualify for capital allowances (with some exceptions, as demonstrated by the aforementioned case).
The SBA provides a flat 3% tax deduction for the cost of purchasing or constructing certain buildings. The proportion of the cost relating to the underlying land and certain other expenses (architects fees, planning fees etc.) is not covered by the relief.
If, in the Stephen May case, the silo was erected after the introduction of the relief, even if HMRC were successful in arguing the silo was a structure and was not plant, the expenditure on the ‘structural’ element of the silo would have possibly then qualified for this relief. Due to the rate of relief (3% p/a meaning it will take at least 33.3 years to receive full tax relief!) it would have been far less advantageous, but tax relief would have still been obtained.
Even with the introduction of the SBA, it remains paramount that when reviewing the allowances for expenditure on buildings, expenditure that qualifies for capital allowances as plant and machinery is identified first and claimed accordingly. The balance, that would have traditionally not qualified for any tax relief, can be considered for SBA.
It would be remiss not to mention that the SBA has one oddity. On the sale of any building on which SBA has been claimed, the tax relief given to the vendor is clawed back on sale. This means, where there is the intention to dispose of the property in the future, SBA is more a deferral of tax than a true saving. However, as is commonplace in farming businesses, where the intention is for the business to be passed down to the next generation and there is no prospect of a sale of the buildings concerned, the tax relief given for SBA does effectively represent a permanent tax saving.
If you would like any further information on capital allowances, specific to the agricultural industry, please do get in touch with Churchgates either by phone (01284 701271) or by email ([email protected]).
