The Current Rules
Capital allowances are given on “plant and machinery” purchased by a business to use in its trade.
Most such capital expenditure goes into a “pool”, and allowances are calculated based on the size of the pool for the year after taking into account the cost of new additions and the sale proceeds of disposals.
Cars costing more than £12,000 are excluded from this pool, and each car has its own separate pool for capital allowance purposes. The same applies to any car which is used for non-business purposes to any extent, so in the case of a partnership or sole trader, this will apply to virtually every car they buy.
Capital allowances are given by “writing down” the amount in the pool by 25% (before April 2008) or 20% (now) per year, and in the case of cars this WDA is limited to a maximum of £3,000 per year. There is then an adjustment (mostly for income tax cases, not for limited companies) to reflect non-business use of the vehicle.
When the car is sold, the sale proceeds are deducted from the expenditure left in the pool for that particular car, and any remaining expenditure is relieved as a “balancing allowance” deducted from the profits of the year concerned. Given that most, if not all, new cars depreciate in value faster than 20% per year, there will typically be a significant “balancing allowance” for the year in which the car is sold.
The New Rules
For cars bought after 1 April 2009 (companies) or 5 April 2009 (sole traders and partnerships), the rules are very different. The rate of capital allowances on a car will depend on its CO2 emissions. Cars emitting more than 160 g/km will attract a writing down allowance of only 10%, whereas those emitting 160g/km or less will be entitled to the 20% rate.
Crucially, the idea of separate pools for each car costing over £12,000 will also be scrapped. Cars will either go into the 20% pool with other normal plant and machinery, or into the 10% pool with such items as “long-life” assets and “integral” fixtures in buildings.
The only exception to this will be cars which are used privately to some extent, as these will each need to be in a separate pool of their own to enable the adjustment for such use to be made. This means, as we shall see, that the changes will have different effects on companies to those they will have on sole traders and partnerships.
If a business leases its cars rather than buying them, there is currently a disallowance of some of the leasing charges, based on the £12,000 cost limit. For cars leased from April 2009, this will change and there will be a flat rate disallowance of 15% for cars emitting over 160g/km, but there will be no disallowance for the “greener” cars emitting 160g/km or less.
This term is used in the tax world to refer to a situation where there is a fundamental change in the rules but the old rules are still applied to expenditure incurred before a certain date. For limited companies, expenditure on cars before 1 April 2009 will be “grandfathered” so that the old rules will apply, and the same applies to expenditure incurred before 5 April 2009 by partnerships and sole traders – though as we have seen, because there is almost always private use of partnership/sole trader cars, the effect on them will be less dramatic and grandfathering will be less significant.
Sadly, like all grandfathers, this one has a limited life expectancy, and in five years’ time, any expenditure in individual pools dating from before April 2009 will be transferred to the general 20% or 10% pool.
Tax Planning – Companies
The key thing about the current rules is that when a company sells a car, because that car has its own pool, there will be a deduction for the full cost (the difference between the purchase and sale price) in the form of a balancing allowance in the year the car is sold.
Under the new rules, this will not occur, because the car will be in a pool with all kinds of other assets, and so there will be no balancing allowance. The company will still be getting writing down allowances at 10% or 20% on the cost long after the car in question has been sold.
Whether or not the company intends to buy a “green” car or a gas guzzler, it will probably be beneficial to do so before 1 April 2009, simply because of this one fact. The more expensive and the “dirtier” the car, the greater will be the difference in the timing of allowances.
If a company buys a new car now and sells it after three years, it will get less than half what it paid for it and the difference will be tax relieved by a balancing allowance. If it waits until after 1 April to buy the car, then at the end of the third year there will be no balancing allowance because the car is in the pool with all the other capital items.
In the case of leased cars, however, the opposite applies. If the car to be leased costs more than £12,000, or in the case of a gas guzzler over 160g/km, about £17,000, then it will be beneficial to wait until after 1 April to change cars.
Tax Planning – Sole Traders and Partnerships
In almost every case there will be some private use of cars bought by these entities, so as each car will continue to have a separate pool of its own, the balancing allowance will still be available on sale as described above. The limit of £3,000 on the writing down allowance on cars costing more than £12,000 will go, so if you are planning to spend more than that on a car it will be beneficial to wait until after 5 April 2009 to buy it.
In the case of leased cars, the position is the same as with companies – it will be better to wait until after 5 April in the case of any car costing over £12,000, and in the case of gas guzzlers, over £17,000.
There is a rather good recession joke going around:
Q: What’s the difference between a financier and a seagull?
A: A seagull can still put a deposit on a Ferrari!
Those out there who can still afford Ferraris will need to think carefully about the timing of the purchase, depending on what sort of entity they trade through.