For an item of expenditure to be treated as an allowable deduction, it must be in form of revenue, rather than being in form of capital. However, relief from taxation may be given in respect of capital expenditure by means of the system of capital allowances; the appropriate allowance being set off against taxable profits in a manner similar to that of relieving losses.
This unit exposes you to the various types of qualifying capital expenditure, types of capital allowances- with their respective rates. It focuses on the provisions of PITA and CITA only. The provisions of PPTA on this same issue are beyond the scope of this course.
At the end of this unit, you should be able to:
- explain the term capital allowance
- discuss the essence of capital allowance in tax assessment
- illustrate the types of capital allowances in the Nigerian tax system
- state the rates of capital allowances- as applicable to every qualifying capital expenditure
- compute capital allowances for tax purposes.
3.0 MAIN CONTENT
3.1 Definition of Capital Allowances
Capital allowance may be defined as a form of standardised depreciation given under income tax laws on certain specified qualifying capital expenditures. They are granted in place of depreciation charges, which are disallowed by the government to the trader/businessman, over a considerable period of time, in order to encourage automation in the industry (Ologhodo, 2007:125).
3.2 Types of Capital Allowances
The system of capital allowances in Nigeria comprises, at least, five types- as shown below.
- Initial or First Year Allowance (IA) – which is claimed when the qualifying capital expenditure is first put into use;
- Annual Allowance (AA) or written down Allowances – which is claimed on the straight line basis over the estimated tax (useful) life of the Qualifying Capital Expenditure (QCE).
- Balancing adjustment – this type of allowance arises where a qualifying capital expenditure is disposed off. The overall idea is to bring the allowance into line with actual expenditure. Where sales proceed is less than the tax written down value at the time of disposal, a balancing allowance is deducted from assessable profit in a similar manner, as both initial and annual allowances. Where on the other hand, the sales proceeds is more than the tax written down value at the time of disposal, a balancing charge is obtained. The tax treatment of balancing charge is to regard it as an additional taxable income. However, in subjecting balancing charge to tax, it is limited to the maximum capital allowance previously claimed on the asset prior to the disposal. The maximum capital allowance claimed is the difference between the original cost of acquisition and the tax written down value at the time of disposal, excess balancing charge is available for capital gains tax.
- 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 (second schedule (paragraph 18 (3))- CITA. The investment allowance is granted at the rate of 10% of qualifying expenditure and such allowances shall not be taken into account in ascertaining the tax written down value of qualifying expenditure.
- Rural Investment Allowance (RIA) – this allowance is granted to companies sited at least 20km away from the provision of electricity, water, tarred road or telephone for the purpose of its trade and which has provided the facilities that the government failed to provide can claim rural investment allowance which is an addition to the initial allowance on such capital expenditure as follows.
(a) No telephone – 5% of capital expenditure on asset in use;
(b) No tarred road – 15% of capital expenditure on asset in use;
(c) No water – 30% of capital expenditure on asset in use;
(d) No electricity – 50% of capital expenditure on asset in use;
(e) No telephone, tarred road, water and electricity (that is, no facility at all, 100% of capital allowance on asset use)
3.6 Basis Period for Capital Allowances
Qualifying capital expenditure bought for the purpose of a trade or business in a basis period gives rise to the right to capital allowances. Capital allowances are calculated by reference to the basis period; and the essence of determining the basis period for capital allowances is to know which tax year will benefit from initial and annual allowances resulting from the acquisition of capital assets.
3.6.1 Basis Period
The basis period for capital allowances is the same as that for the assessment of the profits of a business. This means that capital allowances are given in an assessment year in respect of assets acquired or qualifying expenditure incurred in the preceding year of assessment.