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Explanatory Notes to Capital Allowances Act 2001
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© Crown Copyright 2001 Explanatory Notes to Acts of the UK Parliament are subject to Crown Copyright protection. They may be reproduced free of charge provided that they are reproduced accurately and that the source and copyright status of the material is made evident to users. It should be noted that the right to reproduce the text of these Explanatory Notes does not extend to the Queen's Printer imprints which should be removed from any copies of the Explanatory Notes which are issued or made available to the public. This includes reproduction of the Notes on the internet and on intranet sites. The Royal Arms may be reproduced only where they are an integral part of the original document. The text of this Internet version of the Explanatory Notes which is published by the Queen's Printer of Acts of Parliament has been prepared to reflect the text in printed form and as published by The Stationery Office Limited as the Explanatory Notes to the Capital Allowances Act 2001, ISBN 010 560 201 9. The print version may be purchased by clicking here. Braille copies of the Explanatory Notes can also be purchased at the same price as the print edition by contacting TSO Customer Services on 0870 600 5522 or e-mail:customer.services@tso.co.uk. Further information about the publication of legislation on this website can be found by referring to the Frequently Asked Questions.
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These notes refer to the Capital Allowances Act 2001 (c.2) which received Royal Assent on 22nd March 2001
Capital Allowances Act 2001
EXPLANATORY NOTES1. These explanatory notes relate to the Capital Allowances Act 2001 which received Royal Assent on 22nd March 2001. They have been prepared by the Tax Law Rewrite Project at the Inland Revenue in order to assist readers of this Act and to help inform debate on it. They do not form part of the Act and have not been endorsed by Parliament.
2. The notes need to be read in conjunction with the Act. They are not, and are not meant to be, a comprehensive description of the Act. So if a section or part of a section does not seem to require explanation or comment, none is given.
SUMMARY3. The main purpose of the Capital Allowances Act is to rewrite tax legislation relating to capital allowances so as to make it clearer and easier to use.
4. The Act also makes some minor changes to the legislation. These are within the remit given to the Tax Law Rewrite Project and the Parliamentary process for the Bills it produces.
BACKGROUNDThe Tax Law Rewrite Project
5. In December 1995 the Inland Revenue presented a report to Parliament on the scope for simplifying the UK tax system (The Path to Tax Simplification). The main recommendation was that UK direct tax legislation should be rewritten in clearer, simpler language.
6. This recommendation was warmly welcomed, both in Parliament and in the tax community. After further work on important practical issues and a period of preliminary consultation, the then Chancellor of the Exchequer (the Rt Hon Kenneth Clarke MP, QC) announced in his November 1996 Budget statement that the Inland Revenue would propose detailed arrangements for a major project to rewrite direct tax legislation in plainer language.
7. The project team was given the task of rewriting almost all of the United Kingdom's existing primary direct tax legislation, totalling over 6,000 pages. The aim is that the rewritten legislation should use simpler language and structure than previous tax legislation. The members of the project are from different backgrounds, including Inland Revenue employees, private sector tax professionals and parliamentary counsel including (as head of the drafting team) a senior member of the Parliamentary Counsel Office.
Steering Committee8. The work of the project is overseen by a Steering Committee, chaired by Lord Howe of Aberavon CH, QC. The membership of the Steering Committee as at December 2000 is in full:
The Rt Hon The Lord Howe of Aberavon CH, QC
Consultative Committee9. The work is also reviewed by a Consultative Committee, representing the accountancy and legal professions and the interests of taxpayers. Its members as at December 2000 were:
Consultation10. The work produced by the project has also been subject to public consultation. This has allowed all interested parties an opportunity to comment on draft sections. This consultation is undertaken first through a series of Exposure Drafts which publish sections in draft. The relevant ones for this Act are numbers 3, 5, 7 and 9. They were published in October 1998, April 1999, July 1999 and February 2000 respectively. A draft Act was published for a further consultation in August 2000. Those who responded to one or more of these documents include: Alliance & Leicester plc Association of British Insurers Canary Wharf Ltd Brian Chapman Chartered Institute of Taxation City of London Law Society Confederation of British Industry Construction Industry Joint Taxation Committee Consumers' Association Ernst & Young Federation of Small Businesses Daron H Gunson Holborn Law Society Institute of Chartered Accountants in England and Wales Institute of Chartered Accountants of Scotland Institute of Directors Institute of Payroll and Pensions Management Investment and Tax Publishing Services John Jeffrey-Cook KPMG Law Society of England and Wales London Society of Chartered Accountants National Farmers Union Oil Taxation Action Committee Special Committee of Tax Law Consultative Bodies United Kingdom Oil Industry Tax Committee Yorkshire Water plc Note: this table excludes those who asked that their responses be treated in confidence.
Capital allowances
11. In general taxpayers cannot deduct capital expenditure in arriving at their income or profits. Depreciation in commercial accounts is not allowed as a deduction for tax purposes. Capital allowances, broadly speaking, take the place of depreciation charged in the commercial accounts.
12. Capital allowances give taxpayers relief for certain kinds of expenditure. The Act deals with who gets relief for what expenditure, when and how.
13. Allowances are available mainly for expenditure on:
14. Capital expenditure does not necessarily qualify for any of these allowances. For example, expenditure on commercial buildings normally gives no entitlement to allowances.
15. Some allowances are given only for expenditure incurred in a specific period.
History of capital allowances16. The Customs and Inland Revenue Act 1878 introduced deductions in respect of capital expenditure. It required "the Commissioners to allow such deduction as they may think just and reasonable as representing the diminished value by reason of wear and tear during the year of any machinery or plant used for the purposes of the concern".
17. Allowances for mills, factories and the like were introduced in 1918.
18. The modern era of capital allowances started with the Income Tax Act 1945. This abolished most previous deductions and allowances. (The main exception was scientific research which had been covered by the Finance Act 1944.) It introduced in their place a new system of initial and annual allowances. These covered industrial buildings, plant and machinery, mines, oil wells and other mineral deposits, agricultural buildings and works and patent rights. There were also balancing allowances and charges which, very broadly, gave an extra allowance when an asset was sold or imposed a charge so that the net allowances in total matched the actual depreciation.
19. The basic approach taken in 1945 remains today. Allowances for capital expenditure reduce a person's income or profits for tax purposes. Balancing charges (which may arise when, for example, people sell things) increase their income or profits. But many changes have been made to the legislation since 1945.
20. Investment allowances were given at various times in the 1950s and 1960s. They were followed by cash investment grants.
21. Plant and machinery allowances are by far the most common type of capital allowances. In 1971, a new system of allowances for plant and machinery came in. This gave a special allowance called a first-year allowance in the year expenditure was incurred. The balance of expenditure left over after deducting the first-year allowances was then put into a "pool" of expenditure. Writing-down allowances were given on the balance remaining each year. See paragraph 0 below.
22. First-year allowances were phased out in 1984 but reintroduced in the early 1990s.
23. The rates of allowances for plant and machinery have also changed substantially over the 50-odd years since 1945. The various rates of allowances for writing-down expenditure were reduced in 1962 to just three (15%, 20% and 25%). They were further reduced in 1971 to the single rate of 25%. At the same time, there was a change in the way plant and machinery allowances were calculated to give writing-down allowances on the "pool" of expenditure rather than on each item individually.
24. A 10% rate of writing-down allowances for plant and machinery for overseas leasing was introduced in 1982. A 6% rate for long-life assets was introduced in 1997.
25. Major changes to other allowances were:
26. This means there are today broadly two ways in which allowances are worked out.
27. Allowances for industrial and agricultural buildings, dredging and assured tenancies are given on what is known as the "straight line basis". This basically means the annual allowance is worked out on the basis of the expenditure which qualifies. Then the same allowances is given year by year until all the expenditure is used up. So the expenditure is "written off" in a straight line over time. E.g. for £100,000 expenditure on a factory there will be allowances at 4% of £4,000 a year. After 25 years the total allowances will be £100,000.
28. Allowances for plant and machinery, mineral extraction, patents and know-how are given on what is known as the "reducing balance basis". This basically means the amount of the allowance is worked out again each year on the balance of expenditure less allowances left over from the previous year. So the amount of the allowance goes down year by year as the balance of expenditure reduces. This gives more allowances in the early years compared with the straight line basis. E.g. for £100,000 expenditure on plant or machinery the allowances will be £25,000 in year 1, £18,750 in year 2, £14,063 in year 3 and so on.
29. Most of the legislation dealing with capital allowances was consolidated successively as Income Tax Act 1952, Capital Allowances Act 1968 and Capital Allowances Act 1990. The legislation about allowances for patents and know-how was consolidated in the Income and Corporation Taxes Act 1970 and then again in Chapter I of Part XIII of the Income and Corporation Taxes Act 1988.
30. Most subsequent legislation amended or added to the consolidated legislation. But there are exceptions if legislation is in Finance Acts, Income and Corporation Taxes Act 1988 or other Acts.
THE ACT31. The Act has 581 sections and four Schedules.
32. The sections are arranged as follows:
Part 2 (Plant and machinery allowances) provides allowances for expenditure on plant and machinery. These are relevant to far more taxpayers than any other allowances. They are in aggregate worth far more than other allowances; Part 3 (Industrial buildings allowances) provides allowances for expenditure on buildings and structures which are used in defined ways, such as in manufacturing industry or as a hotel; Part 4 (Agricultural buildings allowances) provides allowances for expenditure on buildings and so on built and first used for farming or other husbandry; Part 5 (Mineral extraction allowances) provides allowances to the mining and oil industries for, mainly, expenditure on mineral exploration and access or on acquiring mineral assets; Part 6 (Research and development allowances) provides allowances to traders for certain expenditure on research and development related to a trade; Part 7 (Know-how allowances) provides allowances to traders for expenditure on certain industrial information or techniques ("know-how"); Part 8 (Patent allowances) provides allowances for expenditure on patent rights; Part 9 (Dredging allowances) provides allowances if there is expenditure on dredging; Part 10 (Assured tenancy allowances) provides allowances for expenditure between 1982 and 1992 on dwelling-houses let on assured tenancies (and similar tenancies) by approved bodies; Part 11 (Contributions) deals with contributions one person makes to another's expenditure. It denies capital allowances for certain expenditure met by contributions from others. But it also gives allowances for certain contributions; and Part 12 (Supplementary provisions) contains provisions for capital allowances for life assurance businesses; additional VAT; oil licences; partnerships, successions and transfers; and miscellaneous other things. It also defines various terms used in the Act and introduces the Schedules.
33. The Schedules are:
Schedule 2: Consequential amendments; Schedule 3: Transitionals and savings; and Schedule 4: Repeals.
COMMENTARY ON SECTIONS34. The commentary which follows is supported by more detailed material in two annexes.
35. Annex 1 contains details of the minor changes in the law made by this Act.
36. Annex 2 gives notes on technical points of interpretation of the sections. These notes concentrate on points where it may not be immediately apparent that the Act preserves the effect of the law.
Glossary37. The commentary uses a number of abbreviations. They are listed below.
38. There is a list of abbreviations used in the Act at the start of Schedule 1 to the Act.
Part 1: IntroductionOverview39. Part 1 introduces readers to capital allowances.
40. Chapter 1 sets out the allowances the Act provides for and how they are claimed and given effect generally.
41. Chapter 2 stops expenditure getting double allowances.
Background42. CAA 1990 does not have an introductory Part. It starts with initial allowances for buildings and structures in enterprise zones. This Act helps readers (especially readers new to capital allowances) by setting out at the start the general provisions in Chapter 1.
43. Chapter 2 is more detailed. It is in Part 1 to signal that taxpayers may have a choice as to which allowances they claim.
Section 1: Capital Allowances44. This section introduces readers to the allowances (and charges) the Act provides for capital expenditure (and some contributions to certain types of expenditure).
Section 2: General means of giving effect to capital allowances45. This section is based on parts of sections 137, 140 and 144 of CAA 1990. It sets out the general means of giving effect to the allowances and charges.
46. Subsection (4) is based on section 834(2) of ICTA. This applies section 6(4) of ICTA to sections 144 and 145 of CAA 1990. Section 6 is referred to in this Act rather than (as in CAA 1990) leaving readers to discover in section 834(2) of ICTA that section 6(4) applies for the purposes of giving effect to capital allowances for corporation tax. Section 6 of ICTA provides that for corporation tax " 'profits' means income and chargeable gains".
Section 3: Claims for capital allowances47. This section is based mainly on section 140(3) and parts of section 141 of CAA 1990 together with paragraph 79(1) of Schedule 18 to FA 1998. It deals with claims for capital allowances.
48. Before this Act, there was no statutory provision which said that capital allowances must be claimed before they are made. That point was, however, established in a tax case in 1987. See Note 1 in Annex 2. Subsection (1) incorporates the point.
49. In CAA 1990, there are numerous references to claims before readers reach section 140(3). That requires any claim for allowances for income tax in taxing a trade to be claimed in a return. For corporation tax the corresponding provision is in Schedule 18 to FA 1998. Subsections (2) and (3) make this key point at the start of this Act.
50. Subsections (4) and (5) give the exceptions in which claims for allowances are not made in a tax return. These are subject instead to the general provisions for claims for income tax or corporation tax. In CAA 1990 section 140(3) (together with section 141(1) and (5)) provides for allowances given "by way of discharge or repayment of tax" to be subject to a claim to which section 42 of TMA 1970 applies in contrast to claims in a tax return where it does not. Section 17(3) of CAA 1990 makes additional provision for claims to carry back balancing allowances in connection with certain mines, oil wells, and so on. Section 528(2) of ICTA provides that a claim is required for patent allowances by someone not carrying on a trade. This Act cuts out the potentially misleading term "discharge or repayment" and refers direct to the provisions under which a claim is made other than in a return.
51. Subsection (5) refers to paragraphs 54 to 60 of Schedule 18 to FA 1998. Those deal with how such allowances must fall to be claimed for corporation tax purposes. This is despite the apparent rule in paragraph 79(1) of that Schedule that claims for capital allowances are made in a company's tax return. See Note 2 in Annex 2.
52. Subsection (6) points readers to the provisions in section 42(6) and (7) of TMA 1970. These require claims for capital allowances for a trade, profession or business carried on by a partnership to be claimed in the "partnership return".
Section 4: Capital Expenditure53. This section is based on section 159(1) and 159(1A) of CAA 1990 and section 532(4) of ICTA. It explains how "capital expenditure" and "capital sums" are used in this Act. Putting these provisions near the start of the Act lets readers see what expenditure does and does not stand a chance of qualifying for allowances.
Section 5: When capital expenditure is incurred54. This section is based on section 159 of CAA 1990. It determines the time when capital expenditure is incurred.
55. Section 159(3) to (6) of CAA 1990 is expressed in terms of the time an obligation to pay "becomes" unconditional. This section is expressed in terms of when there is first an unconditional obligation to pay. This responds to the question "what if the obligation was never conditional?" See Note 3 in Annex 2.
Section 6: Meaning of "chargeable period"56. This section is based on section 160(2) to (6) of CAA 1990 together with parts of sections 161(2) and 147(1) and (2). It defines "chargeable period". This is a term used throughout the Act. It is, broadly, the period for which people work out their entitlement to allowances or liability to charges.
57. Subsection (1) gives the general rule. It is based on part of section 161(2) but omits the words which define a "chargeable period related to" the incurring of expenditure, or a sale or other event, as a reference to the chargeable period in which the expenditure is incurred, or the sale or other event takes place. These words reflect the definition before the introduction of self assessment and the amendments made by section 212 of FA 1994. Before self assessment the "chargeable period related to" the incurring of expenditure referred to the chargeable period in which, or to that in the basis period for which, the expenditure was incurred. But they meant the latter if, and only if, the chargeable period was a year of assessment. With the simplification introduced by self assessment this Act can refer directly to expenditure incurred in a chargeable period.
58. Subsection (1) refers to the accounting period of a company. Schedule 1 gives that the same meaning as in section 12 of ICTA.
59. Subsection (2) gives the general rules for what is the period of account for income tax purposes. Section 160(5) of CAA 1990 applies in terms only to allowances or charges under Parts I to VI and VIII of CAA 1990. In contrast, subsection (2)(b) applies to all Parts of this Act. This is however not a change in the law because the provisions for patents and know-how were previously treated as contained within a particular Part of CAA 1968 and so subject to the same rules; and because R&D allowances are only available to persons carrying on a trade. See Note 4 in Annex 2.
60. Subsections (4) to (6) provide exceptions to the general rule for allowances and charges which go into the calculation of profits of a trade, profession or vocation. They are based on section 160(3), (4) and (6) of CAA 1990. Section 160(6) deals, among other things, with two periods of account which coincide. Subsection (4) does not contain any words to reflect the reference in section 160(6) to the coincidence of two periods. This could happen before self assessment with "basis periods". It cannot now. So it has been omitted from this section. See Note 5 in Annex 2.
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