Capital Allowance is a claim against Assessable Profits by companies when computing their tax liabilities. It is only calculated when a company is computing its tax liabilities. Usually, when companies prepare income statement they always charge depreciation as an expense before arriving at their profit before tax. However, there are different methods of calculating depreciation which can affect how a company’s profit is arrived at which makes equitable calculation of taxation impossible. As such, when computing income tax you must add back depreciation (previously deducted) to the profit before tax before now applying capital allowances.
Types of Capital Allowances;
There are four types of capital allowances
- Initial Allowance (Charged once in the life of an asset)
- Annual Allowance (Charged Annually over the life of an asset after Initial Allowance has been deducted)
- Balancing Adjustment (This arises after when a QCE has been disposed off)
- Investment Allowance (This is granted once in a life of a QCE and is used to encourage investment in certain sectors of the economy).
How is it applied: After Capital Allowances is computed the amount is applied to the Assessable Profit before arriving at the Chargeable Profit. The 30% Income Tax Rate is then applied to the Chargeable Profit. There are however restrictions to how much capital allowances can be deducted from your adjusted profit.
Restriction on Capital Allowances: For businesses other than those in the Manufacturing and Agricultural Sector, the maximum capital allowance that can be claimed can not be more than two-third of the assessable profit. Meaning that tax must be paid on at least one-third of the assessable profit. Here is an example;
Company ABC which is into supplies of chemical equipments reported an adjusted (assessable) profit of N8,000,000. However its capital allowance claim for the year is N12,000,000. His Income Tax payable will thus be;
Assessable Profit N N
Assessable Profit 8,000,000
Capital Allowance 12,000,000
Relieved (2/3 of N12m) (5,360,000) (5,360,000)
Unutilized Capital Allowance c/f 6,640,000
Taxable Profit 2,640,000
Tax Payable 30% 792,000
Conditions for Claiming Capital Allowances: Here are the conditions that must be met before claiming capital allowances;
- The Tax Payer making the claim must own the qualifying capital expenditure. Meaning, the company must own the asset upon which the claim is being made
- The Qualifying Capital Expenditure (QCE) must be used for the purpose of a trade or business. For example, a generator in the home of an MD of a company cannot qualify as capital expenditure. The QCE must also be in use at the end of the period for which the tax is being computed.
- If the Qualifying Capital Expenditure is more than N500,000, then an acceptance certificate must be obtained from the Inspectorate Division of the Federal Ministry of Industry.
Capital Allowance should be computed by a qualified Chattered Accountant as it involves several computation that can be confusing to a novice. However, the above post is expected to give you an idea of what it means. The rates for Capital Allowances can be found here