16.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 28 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:
the introduction of allowances for dredging in 1956;
the extension of industrial buildings allowances in 1978 to some hotels;
the introduction in 1980 of 100% allowances for some buildings in enterprise zones;
the introduction in 1982 of allowances for dwelling-houses let on assured tenancies by approved bodies on a temporary basis (for expenditure up to April 1992);
the revision of agricultural buildings allowances in 1986;
the introduction of allowances for know-how in 1968 which, together with allowances for patents, were brought into line with other capital allowances in 1986; and also then based on “pools” in broadly the same way as plant and machinery allowances; and
the introduction of the new system of mineral extraction allowances in 1986.
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.
