Understanding Balancing Charges
So, what in the world is a balancing charge? It sounds like something from a circus act, right?
A balancing charge is the tax liability that arises when you sell an asset for more than its recorded tax value after claiming Capital Allowances.
Essentially, it’s a way for HMRC to “claw back” some of the tax relief you’ve already received because you’ve now recovered some of the cost of the asset through its sale. It ensures that you don’t receive more tax relief than the actual economic loss you incurred on the asset.
It doesn’t end there…
Just to make things more complicated, other tax reliefs could be hidden under the surface. When calculating a balancing charge, it’s important to consider how the asset has been treated in the tax computations, as well as what tax reliefs (and what type of tax reliefs) have been claimed on the asset up to the point of sale.
Setting the record straight
Capital allowances do not always result in a balancing charge
Okay, here’s where things get interesting. Contrary to popular belief, claiming Capital Allowances does not always result in a balancing charge upon asset disposal. In the majority of circumstances, especially because of Annual Investment Allowance (AIA) and Super-deduction, it is generally a balancing charge as the Tax Written Down Value (TWDV) is nil. When you sell an asset that has been subject to capital allowances, you actually may receive a balancing allowance. This allowance is determined by comparing the sale proceeds with the remaining tax written-down value. If the sale price is lower.
An important point
Capital Allowances claimed on embedded items in a building have no effect on the base cost of the property for capital gains tax purposes. Section 41 TCGA specifically provides that it is not necessary to deduct any Capital Allowances from the cost of an asset for capital gains purposes. So, it is not possible for a Capital Allowances claim to create or increase a chargeable gain. Furthermore, claiming Capital Allowances also has no effect on the calculation of any capital gains indexation allowance that may be claimed.
Exploring Scenarios
Selling 'movable' items of plant, machinery and fixtures
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Scenario 1
A simple scenario…
You sell one item of plant and machinery in a single asset pool (assuming that no other allowances such as Annual Investment Allowance (AIA), First Year Allowances, Super-deduction or Full Expensing have been claimed). The tax written down value is £2,000 and you sell the asset for £3,000. The difference of £1,000 is a balancing charge, and you will be subject to tax on that amount. If it was the other way round, the Tax Written Down Value was £3,000 and you sold it for £2,000, then a balancing allowance of £1,000 would arise and that would be allowed against your tax liabilities.
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Scenario 2
A more complex scenario…
What if you close down your business and sell all your plant and machinery and fixtures and fittings? Again, subject to considering any Annual Investment Allowance (AIA), First Year Allowances, Super-deduction or Full Expensing claimed, the result would likely be similar to the example above, you would have a balancing charge if you sell the assets for more than tax was written down value, and a balancing allowance if you sell them for less.
*Note that special rules apply to the scenarios above as a “clawback calculation” if an asset is disposed of upon which Super-deduction, Full Expensing or Special Rate First Year Allowance has been claimed. It is also worth mentioning that Annual Investment Allowance (AIA) cannot be claimed in the year of disposal of an asset.
Selling a Property
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Example 1
A limited company bought a property in the year 2010 and in 2019. Capital Allowance specialists identified a claim of £200,000 as being available on embedded items in the property. These could include items such as lighting systems, heating systems, fire alarm systems, sanitary ware, etc.)
Annual Investment Allowance (AIA), and other first-year allowances are not available, and therefore the costs are subject to the annual writing down rates of 18% for general/main pool items and 6% for special rate pool items. In 2023 the company sell the property, which includes all the embedded items. The company will have the option of keeping all or some of the allowances or passing them over to the new owner of the property via a S198 Election. As the company is continuing in business and elected to retain all capital allowances they will continue to claim at the annual rates of 18% and 6%.
As a result, no Balancing Charge or Balancing Allowance would be triggered.
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Example 2
A limited company bought the property with exactly the same details as above with regard to the cost of the property and the claimable amount of Capital Allowances.
However, this time the Company is ceasing to trade and selling all its assets in 2023.
Up to the date of sale, the Company has only claimed £50,000 of the £200,000 Capital Allowance available. As the Company has ceased to trade the remaining £150,000 allowances can potentially be brought into account as a Balancing Allowance in the tax computation and used against any tax liabilities due in the final tax computations.
As a footnote, if the ltd company was unable to use any balancing allowances to offset tax liabilities and there was no value in carrying back losses under terminal rules, then consideration should be given to transferring the capital allowances to the new property owner via a Section 198 Election. Potentially, those capital allowances could then be used to negotiate a better sale price for the property.
How a Balancing Charge is Calculated:
The calculation depends on whether the asset was in a general pool or a single asset pool and whether you claimed specific first-year allowances. However, the basic principle is:
- Determine the Disposal Value: This is usually the amount you sold the asset for. If you gave it away or used it privately, it’s the market value.
- Determine the Tax Written Down Value (TWDV) or Pool Balance:
- General Pool: This is the total value of assets in the pool after deducting previous capital allowances.
- Single Asset Pool: This is the original cost of the asset minus any capital allowances claimed on it.
- Calculate the Balancing Charge:
If Disposal Value > TWDV/Pool Balance: The difference is the balancing charge, which is added to your taxable profits.
Example:
Let's say you bought a machine for £10,000 and claimed £7,000 in capital allowances over a few years. The TWDV is now £3,000 (£10,000 - £7,000).
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Scenario 1
- You sell the machine for £5,000.
- Disposal Value (£5,000) > TWDV (£3,000)
- Balancing Charge = £5,000 – £3,000 = £2,000. This £2,000 will be added to your taxable profits.
- You sell the machine for £5,000.
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Scenario 2
- You sell the machine for £2,000.
- Disposal Value (£2,000) < TWDV (£3,000)
In this case, a balancing allowance of £1,000 (£3,000 – £2,000) would arise, which can be deducted from your taxable profits.
- You sell the machine for £2,000.
Special Considerations for First Year Allowances (FYAs) and Annual Investment Allowance (AIA)
- Assets with 100% FYA/AIA: If you claimed 100% relief (e.g., through Full Expensing, AIA, or certain other FYAs), the TWDV becomes zero. If you then sell the asset, the entire sale proceeds will likely be treated as a balancing charge (up to the original cost).
- Assets with Partial FYA (e.g., 50% FYA): The calculation can be more complex, and specific rules apply to how the disposal proceeds are treated.
In summary, a balancing charge is a mechanism to ensure fair tax treatment when you sell an asset on which you’ve claimed capital allowances, preventing you from receiving excessive tax relief compared to the actual cost you bore. It’s an important aspect of managing capital allowances and needs to be considered when disposing of business assets.
Who Is Affected by Balancing Charges and Allowances?
Balancing adjustments affect businesses across all sectors and legal structures:
- Sole traders
- Partnerships
- Limited companies
Assets must fall into one of the following pools:
- Main pool: e.g., computers, office furniture, business tools
- Special rate pool: e.g., integral features, long-life assets
- Single asset pools: used for private-use or ring-fenced assets
The type of pool affects how capital allowances are claimed and how balancing adjustments are calculated.
Do Balancing Adjustments Affect Capital Gains Tax?
No. Balancing adjustments sit within the income or corporation tax regime. They do not directly affect Capital Gains Tax (CGT).
Under TCGA 1992, s41:
- Capital allowances do not reduce the base cost of an asset for CGT
- No double tax relief occurs
- Balancing charges do not create or increase a CGT liability
This separation ensures tax treatment remains consistent and avoids overlapping deductions.
Different Pool Types and Disposal Impact
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General Pool
When all pooled assets are disposed of and a small value remains, that value becomes a balancing allowance.
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Single Asset Pools
Primarily used for mixed-use assets. The adjustment reflects only the business-use percentage. There is no tax relief for any private use of an asset so the private use percentage would also be separated in any balancing charge/allowance situation.
Other single asset pools would include the treatment (where elected for) of short-term assets with an expected useful economic life of less than eight years. In this case any balancing adjustment would take into account the disposal proceeds v TWDV.
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Special Rate Pool
Assets include:
- Electrical systems
- Water and heating systems
- Lifts, escalators, and insulation
Since these attract lower annual writing-down allowances, the gap between TWDV and disposal value is often wider, making balancing allowances more likely.
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Record-Keeping and Reporting
Proper record-keeping is essential:
- Track original asset costs and improvements
- Log annual capital allowances claimed
- Maintain evidence of disposal values (invoices or valuations)
Incorrect data can lead to missed reliefs or tax liabilities. HMRC expects supporting documentation when reviewing balancing charge or allowance claims.
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Timing Considerations
Balancing adjustments apply in the accounting period of the disposal.
- This means profits (or deductions) must be reported in the period the asset is sold or otherwise disposed of.
- Late disposals or errors in reporting can cause misaligned tax returns.
Careful planning, particularly around year-end, can help manage tax liabilities strategically.
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Planning Opportunities
- Asset Scheduling: Plan disposals to fall in a favourable tax year.
- Pooling Review: Check which assets should be separately pooled.
- Professional Valuations: For property or gifted assets, ensure accurate market values.
Tax Forecasting: Use balancing charges/allowances in tax planning to avoid surprises
Implications of Balancing Charges for Different Types of Assets
Intangible Assets
Some businesses may wonder if balancing charges apply to intangible assets like goodwill, patents, or software. Generally, intangible assets don’t qualify for capital allowances under the same rules as tangible assets. However, businesses should seek professional advice, as there may be exceptions depending on the specific asset type or sector.
Mixed-Use Assets
Assets used both personally and for business purposes, such as home office equipment or vehicles, could be more complex to handle. When it comes to mixed-use assets, only the portion of the asset’s value attributed to business use can be considered for capital allowances and balancing adjustments.
Detailed Example of a Business with Multiple Assets
Let’s take a business with assets spread across various pools to understand the nuances further. A company may dispose of office equipment, long-life assets, and integral features in the same year.
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Scenario:
- Main Pool Asset: Office Equipment with TWDV £2,000
- Special Rate Pool Asset: Electrical Systems with TWDV £15,000
- Single Asset Pool Asset: Vehicle with TWDV £3,000
The company sells all three assets for a combined £25,000. The balancing charge for each asset is calculated separately based on their individual TWDV.
How Balancing Charges Impact Cash Flow and Business Planning
Balancing charges can have a significant impact on cash flow, especially for small businesses. If a business unexpectedly faces a large balancing charge, it may result in higher taxable profits, leading to higher taxes due. Effective tax planning can mitigate these impacts by forecasting the potential liabilities and aligning asset disposals with periods of lower taxable profits.
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