Annual Investment Allowance

Most business expenses are fully tax deductible in the same tax year. Until recently, there was an exception for large up-front investments in new equipment and machinery. These investments had to be deducted as they depreciated. This acted as a barrier to business growth and the UK’s system was consistently ranked as one of the developed world’s worst.

At her first Budget, Chancellor Rachel Reeves changed that when she made ‘Full Expensing’ permanent. Now, most, but not all, investments in new ‘plants and machinery’ – a broad category that covers everything from office equipment to industrial robots – can be deducted in full from a business’s Corporation Tax bill in the year it was made. Some categories of plants and machinery didn’t benefit from this change. For example, second-hand equipment wasn’t included. Nor was investment in ‘integral features’ like a new air-conditioning system for a cafe.

That’s where the £1 million Annual Investment Allowance comes in. When first introduced, the Annual Investment Allowance, and its sister relief the First Year Allowances, existed to help SMEs grow by letting them benefit from ‘full expensing’-style reliefs. One big problem, however, was that the allowances jumped around from year to year. For instance, in April 2012 it dropped from £100,000 to £25,000 only to then increase tenfold to £250,000 a year later. After dropping back and forth, it eventually settled on £1 million in 2019.

This was bad for businesses who needed policy certainty to plan out long-term investments, but all that change created fantastic natural experiments for tax economists. One study, exploiting changes in eligibility for First Year Allowances, found the incentives had a big impact. To be precise, a 1% drop in the post-tax cost of investment led to an 8.7% increase in investment.

Further reading

• GOV.UK — Annual Investment Allowance