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Hello sir, actually im getting some issues related with capital allowance treatments. E.g suppose, that if we get question scenerio narrating that a company is evaluating a potential project through NPV METHOD. For that project a company has purchased a machine on last day of previous year. And the sales will be commenced in year 2. So my confusion at this point is how do we calculate capital allowance ? Do we take tax saving on capital allowances in year zero? Or whether we start taking tax saving on capital allowances from year 2 where the tax payment is getting start. !
There is no such thing as year 0. Time 0, time 1, etc are points in time that are one year apart.
Time 0 is the start of the first year and end of the previous year.
Time 1 is one year later and is therefore the end of the first year and start of the second year (we are never worried about one day when it comes to discounting).
Time 2 is the end of the second year and start of the third year.
and so on.With regard to the timing of the capital allowances, then if the asset is bought on the first day of the first year (i.e. time 0), then the allowances are calculated at the end of the first year (time 1). If tax is payable immediately then the tax effect is at time 1. If tax is payable with a one year delay then the tax effect is at time 2.
If, on the other hand (but less likely in the exam), if the asset is purchased on the last day of the previous year (time 0), then the allowances are calculated at the end of the year (time 0). If there is no delay in the payment of tax, then the first tax effect is therefore at time 0. If there is a one year delay in the payment of tax, then the first tax effect is one year later at time 1.
All of this is explained in our free lecture on investment appraisal with tax and I do suggest that you watch it.
(Our lectures are a complete course for Paper F9 and cover everything you need to be able to pass the exam well 🙂 )
Thankyou so much sir for explaining so well. One more thing i want to ask. Sir if company bought asset at start of year 1 but the commencement of sale is in year 3. And tax rule is same year tax rule mentioned in question. So now tell me from when we will take capital allowances? I want to know that whether we take capital allowances from year 1 (when asset purchased) or start in year 3 when the sales (taxable profits) have commenced ? I think that we write capital allowances from year 3 because the sale has been started in year 3 and taxable profits appeared in that year3
Usually in that situation the question does make it clear as to when the allowances start (and usually they say that they start in the first year).
If it doesn’t say, then it doesn’t matter which you assume, provided that (as always) you state your assumption. So much (in question 1 in particular) depends on your assumptions, which is why almost always you are specifically asked to state your assumptions as part of the report.
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