The first year allowance (FYA) is a tax relief that applies in the first year of trading for certain businesses. It allows 100% of qualifying capital expenditure up to £1 million to be deducted from your profits or added to any losses. This means you don’t pay tax on the full amount of your profits in the first year. After the first year, the normal capital allowances rules apply.
What is the first year allowance?
The first year allowance (FYA) allows businesses investing in plant and machinery to deduct the full cost, up to £1 million, from their profits in the first year. This means you can reduce your taxable profits in the first year by the full amount spent on qualifying assets. Any expenditure over £1 million enters either the main pool or special rate pool and receives writing down allowances at 18% and 6% respectively.
The FYA is available to companies, sole traders and partnerships investing in plant and machinery. The main conditions are:
- Your business must be within the scope of corporation tax or income tax.
- Expenditure must be on new, unused plant and machinery.
- Assets must be kept for business use for at least 5 years (or disposed of at market value).
Examples of assets that qualify include manufacturing equipment, lorries, vans, tractors, tools and office equipment like photocopiers and computers.
What happens after the first year allowance?
After claiming the FYA in the first year, your assets enter the main capital allowances pools and receive writing down allowances at 18% or 6% on the reducing balance. Here’s how it works:
Main pool assets
Most plant and machinery assets go into the main pool and qualify for writing down allowances at 18% per year on the reducing balance. For example:
- You buy new machinery costing £200,000 in year 1 and claim the £200,000 FYA deduction.
- In year 2 the pool balance is £200,000. You claim writing down allowances of £36,000 (18% x £200,000).
- In year 3 the pool balance is £164,000 (£200,000 – £36,000). You claim writing down allowances of £29,520 (18% x £164,000).
This continues until the value in the pool reaches zero, when the assets are fully written off against profits.
Special rate pool assets
Some assets qualify for writing down allowances at a lower special rate of 6%. These include integral fixtures like electrical systems, hot and cold water systems, and lifts. The rules are the same as the main pool but with allowances claimed at just 6% per year.
First year allowances: key points
Here are some key points to remember about first year allowances and what happens next:
- The 100% first year allowance is only available in the first year – normally when the asset is first bought.
- The annual investment limit is £1 million for first year allowances.
- After the first year, assets enter the main capital allowances pools.
- The main pool receives writing down allowances at 18% per year on the reducing balance.
- The special rate pool receives writing down allowances at 6% per year.
- Allowances continue until the asset is fully written off against profits.
- There are no balancing adjustments on disposal after the first year allowance.
Advantages of the first year allowance
The first year allowance provides some key advantages in the first year of investment:
- 100% deduction against profits – no tax payable on the amount spent on qualifying assets up to £1 million.
- Provides a tax deferral – tax relief sooner than the normal write-off periods.
- A cash flow boost – the tax saving can improve cash flow in the early years.
- Tax relief against losses – can create or increase a trading loss for offset against other income.
This can provide a useful incentive for new businesses or established businesses looking to invest in plant and equipment.
Disadvantages of the first year allowance
Potential disadvantages to be aware of include:
- Lower allowances in future years – only 18% or 6% per year after the first year.
- Administrative requirements – need to track assets separately in the tax accounts.
- Clawback of allowances if assets sold within 5 years.
- Restricted by the annual investment limit of £1 million.
For very large investments, the normal writing down allowances at 18% may be more beneficial overall.
Who qualifies for first year allowances?
First year allowances are available to unincorporated businesses (sole traders and partnerships) and limited companies subject to corporation tax. The main requirements are:
- Must be within the scope of income tax or corporation tax – so not available to charities or local authorities for example.
- Expenditure must be on new, unused plant and machinery – not second-hand assets.
- Assets must be kept and used for the business for at least 5 years.
Provided the business is a taxable entity and assets qualify, most businesses can claim first year allowances.
What expenditure qualifies for first year allowances?
Expenditure must be on plant and machinery to qualify. This includes tangible assets used in the business such as:
- Manufacturing equipment and machinery
- Lorries, vans and cars
- Tractors, agricultural equipment
- Fixtures and fittings like lighting and shelving
- Office equipment like photocopiers and computers
Expenditure excluded from first year allowances includes:
- Expenditure on buildings, structures and land.
- Second-hand assets.
- Cars with CO2 emissions over 50g/km.
- Assets used partly for non-business purposes.
Your tax advisor can assist with identifying qualifying expenditure.
Is there a limit on the amount of first year allowances?
Yes, there is an annual limit on the maximum amount that can qualify for first year allowances. The limit is:
- £1 million per year for companies.
- £1 million per year shared by related parties for unincorporated businesses.
So a company can claim up to £1 million FYA each year. But for a sole trader or partnership, the total FYA claim across the business and any related parties must not exceed £1 million in a year.
How are first year allowances claimed?
To claim first year allowances, you simply deduct the qualifying expenditure from your taxable profits in the first year. The steps are:
- Identify expenditure on new plant and machinery up to the £1 million limit.
- Deduct this from your taxable profits in the first year it is incurred.
- Add back any disallowed expenditure to the relevant capital allowances pool.
- Report the allowance in the capital allowances computation in your accounts and tax return.
Make sure to keep records of assets purchased and expenditure incurred to justify the FYA claim.
Are there any penalties for incorrect first year allowance claims?
HMRC can apply penalties if incorrect claims are made for first year allowances. Potential penalties include:
- A penalty of up to 100% of the tax underpaid if the incorrect claim is deemed to be deliberate and concealed.
- Penalties of up to 30% for careless or deliberate understatement of allowances.
- A penalty of up to 30% for discovery of fraudulent claim.
- Potential interest charges on late paid tax.
Mistakes can happen but it is advisable to take care when claiming first year allowances. Keep records of qualifying expenditure and make sure claims are supported.
Are there any other first year capital allowances?
As well as the first year allowance, there are also enhanced first year allowances available for some environmentally beneficial equipment, namely:
- Energy and water efficient equipment – 100% first year allowance.
- Electric vehicle charge points – 100% first year allowance.
- Zero emission goods vehicles – 100% first year allowance.
- Gas refuelling equipment – 100% first year allowance.
Your tax advisor can explain these allowances in more detail if they are relevant to your business.
Conclusion
The first year allowance provides a valuable tax relief for businesses incurring qualifying expenditure on plant and machinery. Up to £1 million can be deducted against profits each year. But after the initial allowance, assets revert to the normal capital allowances system with writing down allowances at 18% or 6%.
Care needs taking to ensure claims are correct and supported with evidence of expenditure. But overall the first year allowance is a useful tax incentive for businesses investing in their future.
