While buying and selling equipment and machinery of an organisation, you often hear about the balancing charge and balancing allowance. A balancing charge is calculated when you sell a piece of equipment at a higher tax written down value. For this, you add a balancing charge to your profit. On the other hand, a balancing allowance is deducted from your taxable profits.
This article will define what a balancing charge is and how to calculate it. Besides, we will provide you with a holistic guide on capital allowance and Annual Investment Allowance (AIA), which complement our main topic of balancing charges. So, let’s start!
What is a Balancing Charge?
A balancing charge is calculated to ensure tax relief on your capital cost. It helps you increase the taxable profit ultimately. For example, if you have claimed capital allowance and want to sell your equipment now, you ensure that the sale value and the pool balance are equal. If the sale value is higher than the pool balance, you add the residual to the taxable profit. This addition is called a balancing allowance.
A balancing charge is added to the taxable income if:
Disposal Value > Residual Expenditures (Tax written down value)
How to Calculate a Balancing Charge?
While calculating this value, you need to know about tax written down value and Annual Investment Allowance (AIA). Tax written down value is the original value of an asset when you have purchased it, excluding any capital allowances.
For example, Susan bought equipment at £12000 and claimed a capital allowance of £5,100 for the lifetime of an asset. In this case, the tax written down value is:
Tax written down value = Purchase Price – Capital Allowance
£12, 000 – £5,100 = £6,900
Let’s suppose Susan sells her equipment for £10,000 later. In this case, the disposal value is higher than the tax written down. So, we will calculate it as:
Balancing charge = (Disposal Value + Capital Allowance) – Purchase Price
Once you calculate and get a number, add this amount to the taxable income, increasing the amount of taxable profit.
What is a Balancing Allowance?
A balancing allowance, also called a capital allowance, is the opposite of a balancing charge. It reduces the amount of taxable profit. You can deduct this residual from taxable profit when the value of the sale price of the equipment you have claimed tax relief for is less than the pool balance. As a result, you can withdraw this residual from the taxable income. This residual amount is known as the balancing allowance.
Deduct a balancing allowance from taxable income if:
Disposal Value < Residual Expenditures
However, you cannot claim tax relief if your system is based on the cash system. In other words, it is ideal for an accrual-based business. Moreover, if your company owns vehicles, you can claim tax relief in the cash system.
Furthermore, you can claim tax relief for the net income expenditures in capital allowance. A business can claim capital allowance on research development, fixed assets like machinery and equipment, and company vehicles.
Similarly, you cannot claim tax relief on everyday items—for example, stationery items in your office.
Annual Investment Allowance
Annual Investment Allowance (AIA) is a kind of capital allowance. A business can claim this allowance when a business will purchase equipment and claim a tax relief to cover the 100% qualifying expenditures of equipment.
A business can claim AIA for office equipment, machinery, tools, Lorries, computers, and building fixtures. However, you cannot claim this tax relief for the cars.
A business can claim AIA only up to a specific limit. For example, the UK government set this limit at £200 000, and however, they increased this limit to 1,000,000 on 1st January 2021. But, this allowance will remain active till 31st March 2023.
Finally, a balancing charge is added to the taxable income if the disposal value of a fixed asset is more than the tax written down value. As a result, it increases the amount of taxable income. On the contrary, a balancing allowance is a type of capital allowance. It reduces the taxable income when you deduct residual income from the profits if the tax written down value is higher than the selling price.
However, AIA is another type of capital allowance where you can claim 100% qualifying expenditures of an asset in the UK up to a specified limit. If this limit exceeds the limit set by the UK government, you cannot qualify to achieve Annual Investment Allowance (AIA).
Are you going to buy or sell business equipment and need help regarding tax relief and allowances? Don’t hesitate to give us a call or send an email. Contact us now!
Disclaimer: The information provided in this article, including text, images, and graphics, is general and does not intend to disregard any professional advice.