transfer of business capital allowances

Capital Allowance

A capital allowance is the amount of capital investment costs, or money directed towards a company’s long-term growth, a business can deduct each year from its revenue via depreciation . These are also sometimes referred to as depreciation allowances.

Capital Allowances and Cost Recovery

Governments set depreciation schedules to define when businesses can deduct their capital investment costs from their revenues. The amount of investment costs a business can deduct in a year is called a capital allowance. This is a form of cost recovery , or the ability of businesses to recover (deduct) the costs of their investments.

Capital cost recovery plays an important role in defining a business’s corporate tax base and directly impacts investment decisions. When businesses are not allowed to fully deduct capital expenditures in real terms, they make fewer capital investments, which can reduce worker productivity and wages.

Capital Allowances and Economic Growth

Depending on their structure, capital allowances can have important economic impacts by either boosting or slowing investment which, in turn, impacts economic growth.

Lower capital allowances increase the cost of capital, which leads to less investment and reduces productivity, employment, and wages. For example, a government could lengthen the time frame (depreciation schedule) for the deduction of machinery, which would increase short-term costs and slow or reduce investment in machinery, harming the manufacturing industry.

Conversely, if the depreciation schedule were shortened, or if businesses were allowed to fully expense machinery, businesses would be more inclined or able to invest in machinery and boost production, employment, wages, and spur economic growth.

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What are capital allowances? With examples

No matter the size of your business or the industry you operate in, chances are you own assets that help you earn an income and stay on top of day-to-day operations.

Depending on where your business files taxes, you may be able to deduct the purchase cost or the decline in value of these assets from your taxable income, effectively reducing your tax bill.

This article covers the essentials of tax relief on capital assets, also known as capital allowances.

What are capital allowances?

In a nutshell, capital allowances enable you to reduce your taxable income by accounting for the capital assets you use for your business. 

Capital allowances can typically be claimed on capital expenditure for tangible and intangible assets, including equipment, vehicles, property, research and patents.

There are two main ways capital allowances are treated:

1. Deducting the purchase cost of the asset

In the UK and Ireland, the original cost of an asset can generally be claimed as a capital allowance. Some assets can be deducted in full in the year the expenditure was incurred, while others are spread over several years.

Let’s say a plumber earns $80,000 in one financial year and buys a $30,000 vehicle that is eligible to be claimed in full as a capital allowance. In this case, he can claim a tax deduction of $30,000, bringing down his taxable income to $50,000. However, he can’t claim any further deductions for the cost of the asset after that year.

2. Deducting depreciation of the asset

In many countries other than the UK and Ireland, you generally can't deduct the full cost of capital assets immediately. Instead you claim the cost over time based on the asset's decline in value (or depreciation ).

Let’s say a plumber earns $80,000 in one financial year and owns a work vehicle that declines in value by $7,000 in the same year. In this case, he can claim a tax deduction of $7,000, bringing down his taxable income to $73,000. 

The following financial year he earns $70,000 and his vehicle declines in value by $6,000. He can then claim another deduction of $6,000, bringing his taxable income down to $64,000.

Types of capital allowances

Capital allowances vary from country to country, but some of the most common ones include:

• Equipment and machinery, including computers and workstations
• Research and development costs

It’s worth noting that different types of assets can be treated differently for tax purposes. This means you could be able to claim the full cost of one type of asset in a single financial year, while you might have to spread the cost of another asset over multiple years. 

It’s always a good idea to check with a tax specialist to make sure you understand the ins and outs of capital allowances for your business.

The benefits of claiming capital allowances

Capital allowances can be a bit of a tricky topic, but understanding the nitty-gritty can help you make sure your business is as tax-efficient as possible. Some of the benefits of claiming capital allowances include:

• Reduce your taxable income, and in turn, your tax bill
• Potentially receive a tax refund
• Free up cash flow for your business

With QuickBooks Online, you can quickly and easily record capital expenditure in your chart of accounts so all your capital assets are together in one place. You can also automatically track depreciation of assets purchased, to stay on top of decline in value.

Find out more about how QuickBooks Online can help you save time, stay on top of your finances and grow your business.

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Capital Allowances

Accounting depreciation charged on buildings, plant and machinery, furniture, office equipment and motor vehicles is not deductible for tax purposes.  The law however provides for corresponding deductions on expenditure incurred on certain assets used for the purpose of the business in the form of industrial building allowance, capital allowances, accelerated capital allowance and agriculture allowance.

Industrial building allowance (IBA)

• Qualifying expenditure (QE)

QE for purposes of IBA is the cost of construction of buildings or structures which are used as industrial buildings or certain special buildings. In the case of a purchased building, the QE is the purchase price.

• Buildings that qualify for IBA

An industrial building or a special building includes a building used as / for:

-     a factory

-     warehouse*

-     a dock, wharf, jetty

-     working a farm, mine

-     airport*

-     a hotel registered with the Ministry of Tourism*

-     supplying water or electricity, or telecommunication facilities

-     approved research*

-     a private hospital, maternity home and nursing home which is licensed under the law*

-     an old folks’ care centre approved by the Social Welfare Department

-     childcare centre provided by an employer*

-     a school or an educational institution approved by the Minister of Education / Higher Education / other relevant authority*

-    industrial, technical or vocational training approved by the Minister of Finance (MoF)*

-    motor racing circuit approved by the MoF*

-    service project in relation to transportation, communications, utilities or any other sub-sector approved by the MoF*

-    living accommodation for individual employed by manufacturing, hotel or tourism business or an approved service project*

• For items marked (*), where not more than one-tenth of the floor area of the whole building is used for letting of property, the whole building qualifies as an industrial building. Where more than one-tenth of the floor area of the whole building is used for letting of property, only the remaining part of the building which is not used for the purpose of letting of property qualifies as an industrial building. 
• The MoF may prescribe a building used for the purpose of a person’s business as an industrial building.
• General rates of allowance for industrial building, whether constructed or purchased:

-     Initial allowance (IA): 10%

-     Annual allowance (AA): 3%

Capital allowances

QE includes:

- cost of assets used in a business, such as plant and machinery, office equipment, furniture and fittings, motor vehicles, etc. “Plant” is defined to mean an apparatus used by a person for carrying on his business but does not include a building, an intangible asset, or any asset used and that functions as a place within which a business is carried on.  W.e.f YA 2023, the exclusion of intangible assets will be removed from the definition. However, the MoF may prescribe any asset to be excluded from the definition of plant.  

- the cost of construction and installation of plant and machinery (subject to payment of withholding tax where the installation is carried out by a non-resident)

- expenditure on fish ponds, animal pens, chicken houses, cages and other structures used for agricultural or pastoral pursuits

- where an asset is acquired on a hire purchase term, the QE for a particular basis period is based on the amount of capital repayment made during that basis period

• General rates of capital allowance

* QE for non-commercial vehicle is restricted to the maximum amount below:

• Expenditure on an asset with a lifespan of not more than 2 years is allowed on a replacement basis.

Accelerated capital allowances

Examples of assets which qualify for accelerated capital allowance rates:

Small-value assets not exceeding RM2,000 each are eligible for 100% capital allowances. The total capital allowances of such assets are capped at RM20,000 except for Small & Medium Enterprises (as defined).

Automation capital allowances for the manufacturing sector

Income tax exemption equivalent to the above ACA, to be set-off against 70% of statutory income, is given. Therefore, the total allowances would amount to 200% of the capital expenditure.

The above is enhanced as follows:

i. Scope of automation to include the adaptation of Industry 4.0 elements; ii. Scope of tax incentive is expanded to include agriculture sector; and iii. Capital expenditure threshold for high labour intensive industries, other industries and agriculture be aligned and increased up to RM10 million

(Applications received from 1 January 2023 to 31 December 2027)

Balancing adjustments (allowance / charge) will arise on the disposal of assets on which capital allowances have been claimed. Generally, the balancing adjustment is the difference between the tax written down value and the disposal proceeds. The balancing charge is restricted to the amount of allowances previously claimed.

Capital allowances which have been previously granted shall be clawed back if the asset is sold within 2 years from the date of purchase, except by reason of death of the owner or other reasons the Director General of Inland Revenue thinks appropriate.

Controlled transfers

No balancing adjustments will be made where assets are transferred between persons / companies under common control. In such cases, the actual consideration for the transfer of the asset is disregarded and the disposer / acquirer is deemed to have disposed of / acquired the asset at the tax written down value.

Temporary disuse

Where an asset is temporarily disused for business purposes, it is still entitled for capital allowances provided the asset was in use immediately prior to the disuse and during the period of disuse it is constantly maintained in readiness to be brought back into use for business purposes.

If the disuse ceases to be regarded as temporary, the asset will be deemed to have ceased to be used and any allowances granted during the period of temporary disuse will be clawed back.

Assets held for sale (AHFS)

If an asset is classified as AHFS in accordance with generally accepted accounting principles during the basis period, such asset is deemed to have been disposed of.

Special treatment has been prescribed which may vary the disposal date and / or disposal value of such assets from the normal rules.

Unabsorbed capital allowances

Any unabsorbed capital allowances can be carried forward indefinitely to be utilised against income from the same business source. For a dormant company, the unutilised capital allowances will be disregarded if there is a substantial change in shareholders.

Agriculture allowances

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Capital Allowances Manual

Ca29040 - pma: partnerships and successions: election where predecessor and successor are connected, caa01/s266 - s267a.

Where there is a succession to a qualifying activity and:

• the predecessor and successor are connected with each other,
• both the predecessor and successor are within the charge to UK tax on the profits of the qualifying activity,
• the successor is not a dual resident investing company as defined in CTA09 /109 (formerly ICTA88/S404) (see CTM34530 and CTM34560 ),

the predecessor and successor may make a joint election to treat any assets which:

• belonged to, and were used by, the predecessor for the purposes of the qualifying activity immediately before the succession,
• belonged to, and were used by, the successor for the purposes of the qualifying activity immediately after the succession,

as sold by the predecessor to the successor at a price which does not give rise to a balancing allowance or charge.

This means that where assets are in a pool they are transferred at the pool value.

The definition of connected for these purposes says that the predecessor and successor are connected if:

• they are connected within the meaning of s575 CA11630 ,
• one is a partnership and the other has the right to a share in that partnership,
• one is a body corporate and the other has control over it,
• they are both partnerships and some other person has the right to share in them both,
• both are bodies corporate, or one is a partnership and the other is a body corporate, and some other person has control over them.

This means that an election may be made if:

• the predecessor and successor are connected as defined in CTA10/Ss 34,1122,1123, and ITA07 / Ss993,994 (formerly ICTA88/S839),
• there is common control of them,
• in partnership cases, they have at least one person in common.

The election must be made by notice to HMRC within two years of the succession.

The taxpayers should make any assessments or adjustments of assessments needed as a result of the election.

When an election is made any sale or transfer price is ignored. The successor’s allowances and charges are calculated as if the successor had acquired the assets at the same time and at the same price as the predecessor. This means that the successor’s disposal value is restricted to the predecessor’s qualifying expenditure rather than the notional transfer price.

When an election is made the following legislation does not apply:

• disposal of asset leased overseas to a connected person CA24200 , and
• general successions CA29030 .

If the succession takes place on or after 1 April 2012 for corporation tax (6 April for income tax) and if any of the assets are fixtures the predecessor and the successor will also need to make a joint election under CAA01/S198 in order for the successor to be able to claim allowances CA26470 .

The section 266 election allows for the transfer of all plant or machinery at a value that does not give rise to a balancing allowance of a balancing charge. The section 198 election allows the successor to claim capital allowances on any fixtures that are transferred and, as such, the amount in the section 198 election cannot exceed that amount in the section 266 election.

Cases where election may not be made or has no effect

An election may not be made where the qualifying activity is special leasing.

You may have a case where a business of leasing plant or machinery is transferred and an election is made. In a case like that the election has no effect for leased plant that is qualifying leased plant in determining whether the business is a business of leasing plant or machinery. That is because CAA01/S267, which sets out the effect of the election, does not apply to that plant and machinery. The legislation about disposal value of long life assets CA23770, disposal of asset leased overseas to a connected person CA24200 , and general successions CA29030 can apply.

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