Taxation: Capital Allowance And Loss Relief

To read the previous article on basis period of assessment, please click here

CAPITAL ALLOWANCE

Definition

Capital allowance are a form of relief granted to any company which has incurred qualifying capital expenditure during a basis period in respect of fixed assets in use at the end of the basis period, for the purpose of a trade or business. Capital allowance is granted in lieu of depreciation. Capital allowance covers initial allowance, annual allowance, balancing allowance, balancing charges and investment allowance.

Types Of Capital Allowance

1. Initial Allowance: - This relief is granted in the year of assessment in the basis period of which a qualifying capital expenditure was incurred. In effect, it is an allowance that is granted once in the life of any asset for as long as it is beneficially owned and used by the same owner. It is not pro rated base on the length of the basis period but it is pro rated if there is any private use of the assets.
2. Annual Allowance: - This is granted every year on the residue of qualifying capital expenditure incurred on fixed assets, after deducting the initial allowance and an amount of N10 in respect of every asset which should be retained in the books until disposal. Annual allowance is computed on a straight line basis. The qualifying capital expenditure less initial allowance and N10 residue value in respect of each item of fixed assets is spread evenly over the life of the asset. It is pro rated based on the length of the basis period and that of private use.
3. Investment Allowance: - This is an incentive granted where a company has incurred expenditure on plant and equipment (section 32(1) CITA) or on plant and machinery (2^nd schedule PARA 18(3) CITA. The investment allowance is granted at the rate of 10% of qualifying expenditure and such allowance shall not be taken into account in ascertaining the tax written down value of qualifying expenditure.

    Balancing Adjustments

This will generally arise when a qualifying capital expenditure is disposed off or deemed to have been disposed off. It is obtained by comparing the sales proceeds on disposal to the tax written down value of an asset as at the time of disposal. There are two type of balancing adjustments.

1. Balancing Charge: - This is obtained when the sales proceeds on disposal of a qualifying capital expenditure exceed tax written down value of an asset at the time of disposal.
2. Balancing Allowance: - This is obtained when the sales proceeds on disposal is less than the tax written down value of the qualifying capital expenditure as at the time of disposal

CATEGORIES OF QUALIFYING CAPITAL EXPENDITURE

Categories of capital expenditure that qualify for the grant of capital allowance are as follows: -

a.       Qualifying building expenditure: - that is expenditure on building, structures or work of a permanent nature.

b.      Qualifying industrial building expenditure: - that is expenditure on building or structure in regular use such as a mill factory, mechanical workshop, docks, port and wharf.

c.       Qualifying mining expenditure(expenditure on working a mine, oil well e.t.c)

d.      Qualifying plant expenditure: -expenditure incurred on plant, machinery, and fixtures.

e.       Qualifying plantation expenditure (expenditure incurred on clearing of land for planting e.t.c.)

f.       Qualifying research  and development expenditure: - expenditure incurred on equipment, facilities, patent and licenses e.t.c

g.      Qualifying agricultural expenditure (expenditure incurred on plant and in use for agricultural trade or business)

h.      Qualifying public transportation, new mass transit coach expenditure

Conditions For Granting Capital Allowance

 Capital allowances are granted if the following conditions are satisfied: -

a.       Company must have incurred qualifying capital expenditure.

b.      The claimant must remain the beneficial owner of the asset at the end of the basis period of the company.

c.       The asset must be in use wholly, reasonably, exclusively and necessarily use for the purpose of a trade or business carried on by the company at the end of its basis period.

NOTE: - A period of temporary disuse is ignored for this purpose, provided that the asset is brought into use before disposal. 

Basis Period for Capital Allowance 

The basis period for capital allowance is the same as that for the assessment of the profit of a company. This means that capital allowance are given in an assessment year in respects of assets acquired or qualifying expenditure incurred in the preceding year of assessment.

The basis period of assessment is applicable only in a situation where a normal (12 months) accounting period ended in the preceding year of assessment. However, this is usually not the case on commencement, cessation and change of accounting date. The problems normally associated with the determination of basis period in these situations are two namely: - 
a.       Overlapping basis period 
b.      Gap between basis period 

Overlapping Basis Period 

Occurs when a basis period is common to more than one year of assessment. When there is an overlapping, the period common to both is deemed to form part of the earlier year of assessment, for the purpose of determining the assessment year to which the initial allowance is allocated.  

Basis Period When There is a Gap 

This occurs when there is a gap between the basis periods of two assessment years, this type of situation usually arises when there is a change of accounting date or on cessation of business. When there is a gap or an interval between the basis period for two assessment years, for the purpose of capital allowance, the gap is deemed to form part of the basis period for the latter assessment year except where the latter year is a year of cessation, in which case it forms part of the basis period for the earlier (penultimate) year of assessment. 

Restriction of Capital Allowance 

Capital allowances to be deducted from assessable profits of a company in any year are restricted to 66 2/3 of such assessable profits except for company engaged in agro-allied industry and manufacturing.

Carry Back of Capital Allowance On Cessation of Business 

On cessation of trade or business, unabsorbed capital allowance arising in the assessment year in which trade or business permanently ceases may be carried back for relief against the remainder of profit of the five (5) year of assessment preceding the final year of trading or business.

PRACTICE QUESTION OF CAPITAL ALLOWANCE

QUESTION

Consider the following information for Allied trader limited in respects of some asset disposes.

1. land and building purchased for  N750,000 in 1990 and disposed with a tax written down value of N3,478,750 was disposed off for N1,250,000 
2. Motor vehicle with a tax written down value of N259, 650 was disposed off for N500,000. The original cost was N650,000.
3. A set of office furniture and equipment was sold for N150,000. it originally cost the company N300,000 and the tax written down value at the time of disposal was N179,500.

Compute the balancing charge/balancing allowance

LOSS RELIEF

Definition

Loss Relief is one of the incentive available to business such that losses incurred by the business can be deducted from subsequent years profits. Therefore, to arrive at the total or taxable profits of a company, loss or losses brought forward and capital allowance would be deducted from the profit of the business.

Allowable Losses

1.      The loss must arise from the carrying on of a trade, profession e.t.c. 

2.      The loss must be computed in the same way as profit 

3.      In the case of a partnership, the loss of each partner is personal to the partner who may claim a relief which must be limited to the actual loss of the firm.

Types of Loss Relief Method

1.      Current Year Loss Relief Method

It is applicable only to an individual. It assumes that: -

a.       The actual period in which the loss was incurred is the same as the Year of assessment(actual year basis) i.e. the loss for the accounting year is treated as loss for the year of assessment e.g. loss for Year ended 30/5/2005 is treated as loss for 2005 year of assessment.

b.      The loss of each year of assessment can be set off against income from other sources in that year of assessment.

c.       For an individual to qualify for this relief, a claim in writing to the relevant tax authority has to be made within 12 months after the year of assessment in which the loss was incurred.

N.B losses incurred from property letting business by an individual cannot be relieved in current year basis.

2. Carry Forward Loss Relief Method

It is applicable to both individual and company. Under this method, loses incurred are treated on preceding year basis. This method will apply if no claim is made by the taxpayer for current year loss relief within the stipulated time frame. It will also be applied on any part of a current year loss which is not fully relieved under the current year loss relief. When losses are carried forward, they can be set off against income from the same source from which the loss was incurred originally in the subsequent years. The loss incurred can be carry forward for a maximum period of 4 years.

The following points are to be noted in the application of the rules on carry forward relief for company.

(a)    Trading loss to be deducted from assessable profit of an assessment year shall not exceed the actual loss incurred by the company in the previous assessment year.

(b)   Losses are not to be aggregated with assessable profit in the computation of a company total profit, in strict compliance with the provision of section 31(1) CITA. Consequently, a trading loss from one of the company source of profits cannot be set off against profit from another source. A loss incurred from a particular line of business can only be relieved in future years from assessable profits derived from the same source or line of business.

(c)    When losses incurred in two different assessment year are being carry forward against future profits, the first loss incurred will be relieved in priority to the subsequent loss subject to the four (4) years loss relief period.

(d)   When trade ceases, any terminal loss resulting there from which could not be relieved in the year of cessation due to insufficient or non availability of profit is deemed lost.

NOTE: - The restriction of 4 years does not apply to trading loss incurred by a company engaged in agro allied trade or business.

Practice Questions

QUESTION 1

AK 47 Nigeria limited had sustained losses for years. In 1993, it made a good recovery. The returns for some years showed the following adjusted result

Year ended 31/12/1989                (350,000)

Year ended 31/12/1990                (250,000)

Year ended 31/12/1991                (457,000)

Year ended 31/12/1992                  (75,000)                                            

Year ended 31/12/1993                    79,000

Year ended 31/12/1994                450,000

Capital allowances were correspondingly computed as follows:

      ASSESSMENT YEAR                                  CAPITAL ALLOWANCE

1990                                                                                                          25,000

1991                                                                                                          37,500

1992                                                                                                          32,000

1993                                                                                                          45,000

1994                                                                                                          27,000

1995                                                                                                          35,000

Compute the company tax liabilities for 1990-1995 year of assessment.

    QUESTION 2

    (a) What are the rules governing loss relief for individual.

    (b) Mr. Sotire who has various source of income has the following result            

YEAR ENDED                      RENT              DIVIDEND                TRADE

  31/12/1994                            45,750              24,840                       (74,920)

  31/12/1995                            52,920              24,000                           7,000

  31/12/1996                            57,870                34,920                      12,100

  31/12/1997                            65,830                39,650                      16,850

You are require to compute the total income of MrSotire for all the relevant Year of assessment (March 2001-question 5)