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24A.1.4    Types of Allowance

The UK system uses three types of allowance:⁹

1. an initial or first year allowance¹⁰ of a substantial percentage of the capital expenditure, only a few of which are currently available;
2. a writing down allowance during the life of the asset, which clearly does not apply if a 100% initial allowance has been used;
3. a balancing adjustment which may take the form of either an allowance or a charge on the occurrence of an appropriate event such as the end of the trade or the disposal of the asset.

The third technique is designed to bring the allowances into line with actual expense. If the amount so far allowed is less than the amount spent, an extra or ‘balancing’ allowance is permitted. If, however, the allowance exceeds the expense, a sum is imposed by way of ‘balancing charge’ to recapture that part of the allowance which was not needed. The charge recovers only the amount that has been allowed, any excess being a matter for CGT. There is no provision whereby the balancing charge may be spread over the number of years for which the allowance was claimed, so the tax charged might, in extreme circumstances, exceed the tax saved through the allowance. Today, a balancing charge is treated as a receipt of the trade or other type of qualifying activity or business.¹¹ FA 2003, this provision introduces an anti-avoidance measure (CAA 2001, section 570A) which denies a balancing allowance where the sale proceeds have been reduced by tax a avoidance scheme; this rules applies to the allowance for industrial buildings in part 3 of the Act but also to those for Agricultural Land (§24.4) Flat Conversions (§24.4A) Mining (§24.5) and Assured Tenancies (§24.10).

Writing down allowances may be given on a straight line basis so that the same amount is written off each year and all the expenditure will be written off after a certain number of years—so the industrial buildings allowance of 4% will write off the expenditure of £100,000 at the rate of £4,000 a year and will have written off the whole sum after 25 years.

Writing down allowances may also be given on a reducing balance basis so that the same percentage, eg 25% is given each year but applied to a reducing balance of expenditure. So £100,000 of expenditure attracting an allowance at 25% will give rise to an allowance of £25,000 (25% of £100,000) the first year, leaving £75,000 as the balance of expenditure not yet written off; the allowance for the second year will be £18,750 (ie 25% of £75,000), leaving a balance of £56,250 for the third year; 25% of £56,250 is £14,062.50. The reducing balance achieves total write off only after an infinite number of years, which will take longer than the lifetime of any business.

24A.1.4.1    Example

A buys an asset for £1,000 and has claimed £500 allowances when selling it for (a) £600;

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