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Capital Allowances |
3 |
24A.1 Introduction |
24A.1.1 The Problem |
Expenses incurred in the acquisition of a capital asset are not deductible in computing the profits of a trade.3 If the asset has a limited life, its value to the business will decline. The causes of this decline may be physical, such as wear and tear on Plant and Machinery, or economic, such as obsolescence or a change in trading policy. The decline causes the cost of the asset to become an expense to the company for accounting purposes; the capital has been consumed. Accounting principles recognise this cost by allowing a deduction for depreciation for accounting purposes, but no provision was originally made for tax purposes, perhaps because income tax was thought to be only temporary. |
The UK tax system has relaxed this strict approach by making allowances for certain capital expenditure, including the capital allowance system. When claimed, capital allowances displace the deductibility of expenditure on renewals.4 The structure of the present system goes back to the Income Tax Act 1945, which defined certain types of capital expenditure qualifying for allowances, and specified different rates of allowance. Broadly speaking, the list is the same today, although there have been changes in the way in which the allowances are made. The legislation was consolidated in the Capital Allowances Acts of 1968 and 1990, now superseded by the CAA 2001. |
| 24A.1.2 History5 |
The first statutory allowance was granted in 1878 ’as representing the diminished value by reason of wear and tear during the year’ of Plant and Machinery used in a trade. This allowance was held not to extend to obsolescence, a matter changed by concession in 1897 and by statute in 1918. Also in 1918 special depreciation allowances were made to mills, factories and other similar premises,6 on the basis that the vibrations from the machinery might weaken the building. The Royal Commission of 1920 considered, but rejected, any general scheme of capital allowances. |
The Income Tax Act 1945 took a wider view; the basic structure remains in place today. It defined those types of capital expenditure which qualified for allowances; many did not—and still do not—qualify. Apart from allowances for Plant and Machinery, all allowances were confined to income taxable under schedule D, case I (some clearly to particular trades), and did not extend to schedule D, case II or schedule E. A few allowances applied to schedule A, which were widened by FA 1997.7 |
24A.1.3 Accelerated Allowances |
For many years the tax system enshrined the belief that tax allowances encouraged investment. Hence, elaborate allowances were given to allow the writing-off of capital expenditure far ahead of any real depreciation or obsolescence. However, legislation in 1984 and 1985 reduced the rates of allowances, making them closer to actual depreciation, and compensated for this by reducing the rate of corporation tax. This has not prevented Parliament from reviving specially enhanced allowances from time to time. Those who believe that adjusting allowance affects the overall level of investment point to the fact that capital investment by UK businesses is a lower percentage of GNP than spending by either consumers or governments; it is also much more volatile.8 |