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Background:
There’s a past exam question in which the company is undertaking a project entailing immediate capital expenditure of $800 million at 1 July 2008 and with
projected revenues over five years as follows:30 June 30 June 30 June 30 June 30 June
Year ended 2009 2010 2011 2012 2013Revenue ($ million) 680·00 900·00 900·00 750·00 320·00
The company pays tax at 30% on its taxable profits and can claim a 50% first year allowance on qualifying capital expenditure followed by a writing down allowance of 40% applied on a reducing balance basis.
Given the timing of the company’s tax payments, tax credits and charges will be paid or received twelve months after they arise.
My question :
My question to you is that when doing a working of tax savings on capital allowances in which year the first capital allowance will come? i.e either in year 1 or year 0?
Kindly explain this to me with reason as I am finding it challenging in exam question to decide whether the first capital allowance will come in year 0 or year1.
Please tell me the name of the question so that I can check on the exact wording.
However, the normal situation is this:
Tax is calculated at the end of the financial year, and if there is a one year delay in paying/saving tax, then then tax flow is then one year after the end of the financial year.
So in the case of the information you have given, the first capital allowance and therefore tax saving will be calculated on 20 June 2009 which is time 1. The tax saving itself would occur 1 year later which is at time 2.
For a full explanation of the tax rules please watch my free lectures (or better still, because the tax rules are the same as for Paper FM watch my Paper FM lectures on investment appraisal with tax).
The name of the question is NEPTUNE Co and part (a) of the requirement which requires us to calculate the APV. Kindly look at the question then please let me know.
This question specifically says that the ‘tax credit and charges’ are 12 months after they arise. So given that the capital expenditure was on 1 April 2008 (time 0), the first capital allowance saving will be 12 months later i.e. at time 1. This is what the examiner has done in his own suggested answer.
(However this question was set by a previous examiner and this is not the way that capital allowances actually work in practice. Much more likely with the current examiner it would follow the correct tax rules in which case the first allowance saving would be at time 2 as I explained before.)
As per my understanding of the concept ,
As the asset was purchased on the first day of the start of the year(i.e 1 July 2008) so there will be a full year’s capital allowance in year 1 and the savings of this year 1 capital allowance would come in year 2 as the question states its in arrears.
If the asset would have been purchased on 30 June 2008 i.e , on the last day of the previous year then the first capital allowance would have come in year 0 and the savings on it would have been claimed in year2. Please tell me if I am right ?
Yes, you are right (and is as I was explaining in my previous reply).
The examiners answer to this particular question treats it differently, but it was set by a previous examiner. The current examiner will expect you to treat it as you have written (and as I wrote also).
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