Capital Allowances and the Timing of a Plant Purchase
Pennard Fabrication Ltd has a 31 March year end and prepares accounts to that date. In the year to 31 March 2025 it makes a trading profit before capital allowances of £420,000. It is considering buying a new CNC machine for £300,000. Two options:
- Option 1: buy and bring into use in February 2025 (year to 31 March 2025).
- Option 2: delay purchase and bring into use in May 2025 (year to 31 March 2026).
The company is a going concern with taxable profits well above the annual investment allowance limit in every year. The finance director wants to know which year to take the relief in and whether the timing actually matters.
1. Explain how the Annual Investment Allowance applies to this purchase and quantify the tax relief in each option, stating any assumption about the rate of corporation tax.
Read the worked answer
AIA: plant and machinery qualifies for the Annual Investment Allowance, which gives 100% relief on qualifying expenditure up to the limit in the period. The AIA limit is £1m for expenditure in accounting periods of 12 months (apportioned for shorter periods). The FD's statement that profits exceed the limit every year is irrelevant to AIA - the limit is on expenditure, not profit. However, if the company has already used its AIA on other expenditure in the same period, the machine may fall to writing-down allowance at 18% (main pool) or 6% (special rate pool).
Assumption: AIA is available in full and corporation tax is at 25% (profits of £420,000 are above the £250,000 upper marginal limit, so the main rate applies; if marginal relief applied the effective rate would differ).
- Option 1 (year to 31 March 2025): AIA £300,000 → taxable profit £120,000. Tax at 25% = £30,000. Relief worth £75,000, obtained ~12 months earlier than Option 2.
- Option 2 (year to 31 March 2026): taxable profit 2025 = £420,000 → tax £105,000. In 2026, AIA £300,000 reduces profit (assuming 2026 profit of at least £300,000) → relief worth £75,000, but one year later.
Timing value: the £75,000 cash tax saving is deferred by 12 months under Option 2. At a 6% cost of capital that is a real cost of roughly £4,500. Option 1 is preferable on tax grounds alone. But note: relief is only obtained when the asset is brought into use, not when ordered or paid for, so the contractual delivery date drives the answer, not the order date.
2. The FD asks whether it would be better to lease the machine instead. Outline the tax and commercial factors that should govern the lease-versus-buy decision, and state what additional information you need.
Read the worked answer
Tax factors:
- Buying: the company claims AIA (or WDA) and owns the asset; any sale proceeds later create a balancing charge/allowance.
- Leasing: the lessor owns the asset and claims the allowances; the company instead deducts the rental payments as a trading expense in the period they are incurred. Relief therefore spreads over the lease term rather than accelerating up front.
- The after-tax cost comparison must discount both streams at the company's post-tax borrowing rate.
Commercial factors: cash flow profile (lease avoids a £300,000 outflow but commits to fixed rentals), balance sheet treatment (a lease may be an on-balance-sheet liability under current lease accounting, affecting covenants and gearing), flexibility if the machine becomes obsolete, maintenance and residual value risk (retained by lessor and priced into rentals), and whether the asset is needed beyond the lease term.
Information required: the lease term and rental amount; whether the lease is a finance or operating lease for accounts purposes; the company's cost of capital and borrowing rate; expected residual value and useful life of the machine; whether the company has AIA capacity remaining in the relevant period; and any covenant restrictions on additional debt. Without the rental figures and the discount rate, no numerical recommendation can responsibly be made - the answer should say so rather than guess.