Instrument purchases and expensing them in your accounts and tax return.
Let’s clean up a couple of terms here, as many people as about capital gains tax on their instrument purchases instead of capital allowances on their instruments.
Capital Gains Tax is a tax on the profit when you sell (or ‘dispose of’) something (an ‘asset’) that’s increased in value. It’s the gain you make that’s taxed, not the amount of money you receive. It can apply for items purchased for personal use eg a painting purchased for £5000 and you sell it at auction x number of years later for £25000. You have made a gain of £20,000 and that gain is subject to tax. The capital gains tax threshold is changing, so depending on when you sold the asses as you get an annual allowance on the gain in the year of sale. You don’t get a rollover of this allowance if it is unused. It is the same if you stop being self-employed or retire and you keep the instruments for pleasure. A much longer knowledge base article will be issued on the complications of this.
Having established what is applicable for capital gains tax, what is capital allowances?
This is when you purchase say your own instrument, computer, cane-making equipment, phone maybe, and it’s a fairly high cost to you and likely to last more than two years. It’s not things like a music stand, some cables, (mind you, you very rarely find the cables after you’ve purchased them), a mouse, a computer keyboard, et cetera.
On the whole, there are two types of capital allowances available.
The first year allowance or it’s also known as the annual investment allowance for the small business. And then you can have a writing down allowance. The first year allowance is 100% of your spend in the year that you purchase the item, not necessarily paid for it but the year you set up the liability.
The second writing down allowance is 18% per annum based on the written down value each year.
To explain the writing down allowance a bit more, if you have something that costs you £2000, you can take a capital allowance of 18% of £2000 is £360. The value for year two is not £2000, but it’s £2000 less £360, to the tax value to write down is £1640. This is known as the tax value. It can take up to 24 years to fully write off an item.
For instruments, what you always have to look at is if the instrument is going to hold its value over time, if it might have a fall in value, or whether it indeed could increase in value.
Normally I have found that expenditure on named stringed instruments hold their value and can even go up. If you write off the value in the year of purchase, then yes, you will lower your profit for the year and obviously then get a lower tax bill, but if you then sell the in instrument for more than its tax value, bear in mind the tax value is zero now, you need to declare this in the capital allowances section as a balancing charge.
You effectively then end up repaying a proportion or maybe all of the capital allowance taken. That’s great, but if you are a 40% taxpayer in the year you sell the instrument and you only got relief at 20%, then you are likely to be repaying more than what you received. I’m sure there’s a way around to make sure you only pay back what you’ve already taken as an allowance. But that requires me to do a bit of digging, which I will do.
Instruments not likely to lose value:
If you have an instrument that is not likely to lose the value, I suggest not taking any allowance, but keeping the details in your bookkeeping so you can’t lose the information, and just claim any repairs you might have, or just take a very small percentage, say 2% just to recognise the fact you have spent on this instrument. I tend to do this a lot with harpists and just put 2% through on their main harp. Of course, you could buy student instruments, in which case they probably won’t hold the value and you could decide to write it off all in one year or do it at a higher percentage and then write it off when the pool of assets value gets less than £1000.
Now here comes the fun problem.
All of this disappears if you are using the cash basis for your accounts. You would have to claim the write off or the expense of the whole instrument the year you buy the instrument in the main body of your accounts, or rather the year you paid for the instrument. If you are paying for it via a loan, then you will be expensive the loan amount. That’s a pretty rubbish method to be perfectly honest. It only works well if you’ve got a lot of profit because what can happen is, let’s say you’ve only got £15,000 profit, but you bought a £17,000 violin, you have to write that £17,000 off so you’ve got no profit and you can’t use your personal allowance because you’ve used all the profit you had on writing off the violin.
You really have to think about when you buy instruments and how you do your accounts.
If you have a £15,000 profit and you bought a £17,000 instrument, and you go for the normal accounting method, then you can choose to only take a first-year allowance of £5,000 to bring you back down to your personal allowance and therefore not having to pay tax. Yes, you will have to pay national insurance.
Have a real think about instrument purchases. If you have PAYE income that’s quite high, now that’ll be no problem if you then write off the instrument of £17,000 on a £15,000 profit because the extra bit will then reduce your overall income and potentially you could get some tax back off your PAYE.
It’s always a bit of a juggle the first year you buy an instrument and what is the best thing for it? You do have to get your crystal ball out to think about it, is this an instrument I’m going to keep forever? Is this one I’m likely to sell or just don’t know?
The safest thing, to be honest, is to use the accrual method of accounting for all your accounts, not the cash basis, and then slowly write off that instrument over time. If of course, you make a loss on the instrument, so it’s finally written down to let’s say £5,000 and you sell it for £4,000, you then get a balancing allowance of £1000. So all is not lost if you sell it for less than the tax value.
Please always seek advice on this. It can be a little bit complicated.
For much more information on capital allowances, please view the video and transcript on our knowledge base >> https://bit.ly/433LGed