Annual investment allowance

The annual investment allowance (AIA) was temporarily increased from £200,000 to £1 million for two years, from 1 January 2019 to 31 December 2020. The allowance reverts back to its usual level of £200,000 from 1 January 2021. While the COVID-19 pandemic may have put projects on hold, you may want to review planned capital expenditure to ensure that the deadline for benefitting from the increased allowance is not missed. Particular care should be taken to avoid falling foul of the transitional provisions.

Nature of the AIA

The AIA provides immediate relief for capital expenditure up to the available limit when calculating taxable profits – qualifying capital expenditure up to the level of the AIA can be deducted in full. However, there is no requirement to claim the AIA for all the qualifying expenditure – writing down allowances can instead be claimed for some or all of the expenditure.

Where capital expenditure in a period exceeds the available AIA, relief for the excess is given in the form of writing down allowances.

Calculating the AIA

The amount of the AIA depends on when the accounting period falls. If the accounting period falls wholly within the period from 1 January 2019 to 31 December 2020, the AIA is £1 million, proportionately reduced for periods of less than 12 months. If the period spans 31 December 2020, the AIA for the period must be calculated.

Accounting period ends 31 December 2020

If you prepare your accounts annually to 31 December, for the year to 31 December 2020, you have an AIA of £1 million. This falls to £200,000 for the year to 31 December 2021.

If you are planning capital expenditure in excess of £200,000, funds permitting, you may wish to go ahead in 2020, rather than 2021, to enable you to benefit from the increased AIA and obtain immediate relief in full for qualifying capital expenditure of up to £1 million.

Accounting period spans 31 December 2020

If your accounting period spans 31 December 2020, you will need to be aware of the transitional rules. The first step is to calculate the AIA for the period. This is done by reference to the proportion of the period falling on or before 31 December 2020, in respect of which the annual limit is £1 million, and the proportion of the period falling after this date, in respect of which the annual limit is £200,000. Thus, if your accounting period is the year to 31 March 2021, you have an AIA for that period of £800,000 ((9/12 x £1 million) + (3/12 x £200,000)).

However, that is not the end of the story — there is also a cap on the amount of expenditure incurred on or after 1 January 2021 which can qualify for the AIA. The cap is y/12 x £200,000, where y is the number of months in the period falling on or after 1 January 2021. So, if the accounting period is the year to 31 March 2021, the cap is £50,000 (3/12 x £200,000). This means that while the AIA for the year to 31 March 2021 is £800,000, only expenditure of up to £50,000 incurred on or after 1 January 2021 will qualify for the AIA.

Consequently, to take advantage of the increased AIA for the period as a whole, timing is key and the bulk of the expenditure must be incurred in 2020 rather than delayed until 2021. If you spend £800,000 in November 2020, the full amount will be eligible for the AIA; however, if you spend £800,000 in February 2021, because of the cap, only £50,000 of the expenditure will qualify for the AIA, despite the fact that the AIA for the year to 31 March 2021 is £800,000.

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