Tax Relief, Capital allowances are nothing but the tax equivalent of depreciating property, and the mechanism by which tax relief is given for certain specific items of capital expenditure. However, even in case of ordinary tax relief, capital allowances can be quite limited; as a result, entrepreneurs must be well aware of how to appropriately manage their business’ capital. Capital allowances can be calculated by adding the total cost of assets divided by the total income of an enterprise. However, with the advent of new laws and regulations, the effective use of tax relief in business has also significantly changed. Today, tax relief is provided for a wide range of business activities such as depletion of plant and equipment, transfer of depreciated liabilities, re-investment, development of plant and property, and payment of expenses and charges.
Depletion of plant and equipment is one of the most significant tools for increasing cash flow in an organization. But it is also one of the most misunderstood areas in terms of tax relief. While the aim of depreciation is to lower the total value of an asset over a period of time, the effect on cash flows can be the opposite. By allowing depreciation to reduce the tax liability of an enterprise, the necessary funds for investment in plant and equipment may be removed from the company’s balance sheet, reducing its net worth. The government, on the other hand, claims that depreciation or even transfer of these resources reduces the amount of tax that the company has to pay.
The new tax relief legislation which came into force in the first half of this year will no doubt affect businesses in different ways. One of the major areas of concern is the reduction of the allowance for interest on eligible permanent worldwide assets. Under the existing rules, a firm that has not claimed this tax relief privilege in the previous year is liable to make an application to increase the allowance, thereby reducing its taxable income. A number of large multinational firms had asked to continue this privilege, but now they might have to pay the full amount.
The second area of tax relief to be tackled is capital allowances. These are typically used to offset the costs of doing business, such as the purchase of new buildings, the expansion of existing offices and so on. According to the authorities, it was wrong to conclude that capital allowances were expenses, since the cost of establishing a new office can run to several millions of dollars. And, as businesses expand, they may have to pay the same amount in addition to the original capital allowances.
The authorities argue that, by allowing the deduction of this expense, tax relief encourages entrepreneurs to spend money in areas that help them earn more profits, rather than merely spending what they earn. Nevertheless, the allowance for the balancing charge has already been reduced considerably, causing many firms to cut down their activities in certain businesses. This, they argue, encourages inefficient management of resources, causing loss to the national economy. Moreover, it costs the government billions of dollars annually in subsidies and social contributions.
To reduce the cost of social benefits, the authorities have introduced a tax credit which caps the amount of tax relief that can be claimed at 1m. The cap means that only that much can be deducted from the entrepreneur’s capital. For example, if an individual wants to claim the maximum annual investment allowance, he or she would have to source the whole capital to that allowance. This has caused many small and medium firms to cut down on their working capital because they cannot credibly claim tax relief of this kind.
Yet another area of tax relief that has been reduced is the capital expenditure. By eliminating the allowable deduction for business expenditure, the tax relief has made it possible for entrepreneurs to save a lot more on their tax payments. The elimination of tax relief for capital expenditure means that entrepreneurs and companies will have to use their profits on business activities instead of on tax payment. This has meant that many businesses have shut down because they did not have the financial means to run their day-to-day operations.
One other tax relief that has been substantially reduced is the tax relief available for business assets. Previously, individuals were allowed to deduct the full value of their qualifying dividends and capital gains. This tax relief was also subject to a complex tax calculation, which resulted in a much higher tax burden for the entrepreneur. The tax relief is now limited to the individual’s tax liability for the year in which he or she earns the income. Also, the tax reduction applied to the qualifying profits is now only applicable up to the first $30k of qualifying profits. With this change, entrepreneurs are now able to take advantage of a greater tax reduction on their dividends and capital gains.