All businesses must prepare accounts to show profit or loss for a set accounting period, usually of 12 months. Profits consist of chargeable receipts minus deductible expenses and capital allowances.
Chargeable receipts refers to money received for the sale of goods and services. This excludes profit on items used in the course of trade, such as an office premises sold at a profit.
Deductible expenses are those incurred ‘wholly and exclusively’ in the course of trade, which means things like salaries, rent on commercial premises, utility bills, stock and interest payments on borrowing.
Capital items cannot be deducted from chargeable receipts for the purposes of calculating profits, but companies are granted a capital allowance, allowing them to deduct a proportion of the cost of such items.
Each financial year, a business is entitled to a writing down allowance of 18 percent of the value of the plant and machinery, valued at the start of the financial year.
The writing down allowance (WDA) is a type of capital allowance that UK companies can claim on the cost of their qualifying plant and machinery. Here are a few examples of how the writing down allowance might be applied to a company’s profit calculation in the UK:
Example 1: ABC Ltd. is a manufacturing company that purchased a new machine for £100,000 during the financial year. This machine qualifies for a WDA of 18%. The company can claim a WDA of £18,000 (18% of £100,000) against its taxable profits for the year. This means that the company’s taxable profits will be reduced by £18,000.
Example 2: XYZ Ltd. is a construction company that purchased a new van for £20,000 during the financial year. This van qualifies for a WDA of 18%. The company can claim a WDA of £3,600 (18% of £20,000) against its taxable profits for the year. This means that the company’s taxable profits will be reduced by £3,600.
Example 3: PQR Ltd. is an IT company that purchased new computer equipment for £50,000 during the financial year. This computer equipment qualifies for a WDA of 6%. The company can claim a WDA of £3,000 (6% of £50,000) against its taxable profits for the year. This means that the company’s taxable profits will be reduced by £3,000.
In each of these examples, the writing down allowance is used to reduce the company’s taxable profits, which in turn reduces the company’s tax liability. By claiming the writing down allowance, companies can reduce their tax bills and reinvest the savings back into their businesses.
Businesses are also entitled to an annual investment allowance (AIA), which allows them to deduct the whole costof new plant and machinery purchased in that particular accounting period currently up to the value of £1,000,000.
The annual investment allowance (AIA) is a type of capital allowance that UK companies can claim on certain types of qualifying expenditure, such as plant and machinery. The AIA allows companies to deduct the full cost of their qualifying expenditure from their taxable profits, up to a specified limit. Here are a few examples of how the annual investment allowance might be applied to a company’s profit calculation in the UK:
Example 1: ABC Ltd. is a manufacturing company that purchases a new machine for £150,000 during the financial year. This machine qualifies for the AIA, which has a limit of £1 million. The company can deduct the full cost of the machine (£150,000) from its taxable profits for the year. This means that the company’s taxable profits will be reduced by £150,000.
Example 2: XYZ Ltd. is a construction company that purchases a new crane for £500,000 during the financial year. This crane also qualifies for the AIA. The company can deduct the full cost of the crane (£500,000) from its taxable profits for the year, up to the limit of the AIA (£1 million). This means that the company’s taxable profits will be reduced by £500,000.
Example 3: PQR Ltd. is an IT company that purchases new computer equipment for £200,000 during the financial year. This computer equipment also qualifies for the AIA. However, the company has already claimed £800,000 of AIA on other qualifying expenditure during the year. As a result, the company can only claim the remaining AIA of £200,000 on the computer equipment. The company can deduct the full cost of the computer equipment (£200,000) from its taxable profits for the year. This means that the company’s taxable profits will be reduced by £200,000.
In each of these examples, the annual investment allowance is used to reduce the company’s taxable profits, which in turn reduces the company’s tax liability. By claiming the AIA, companies can reduce their tax bills and reinvest the savings back into their businesses.
A useful blogpost on capital allowances can be found here: Annual investment allowance or writing down allowance? – Arthur Boyd & Co