Taxation
Cash flows associated with taxation must be brought into the assessment of the project. Most projects will cause differences in corporation tax. This may be because of
capital expenditure attracting relief (capital allowances), profits from the project
attracting additional tax or losses attracting tax relief. These differences must be taken
into account in investment appraisal.
The taxable profit
Businesses are taxed on the basis of the profit shown by an income statement drawn
up following the generally accepted accounting rules and conventions. This profit
figure is, however, subject to some adjustment. There are certain items of expense and
revenue that, though legitimately appearing in the income statement, have been singled out by the law as being illegitimate for tax purposes.
Most of these items are fairly unusual in occurrence or relatively insignificant in
effect, though there is one that is typically neither rare nor trivial. This is depreciation,
the accounting device for spreading capital costs of non-current assets over their useful lives. For tax purposes, depreciation must be added back to the profit revealed by
the income statement, to be replaced by capital allowances.
Relief is granted by allowing businesses to deduct 4 per cent of the cost of the building from the taxable profit in each year of its ownership and use. On disposal the proceeds will cause a claw-back of excess allowances or an additional allowance, if the
difference between cost and the disposal proceeds has not already been fully relieved.
Capital allowances
Capital allowances are set against the taxable profit to give tax relief for expenditure
on non-current assets. There are several categories of asset into which the law has placed
the various types of business non-current asset. Each of these has its own rules for
granting the allowance. In practice, two of these, dealing with plant and machinery
and with industrial buildings, are by far the most important to the typical business.
Plant and machinery
This includes a wide range of assets, from industrial machinery to the reference books
of a lawyer, and includes motor vehicles. For expenditure on plant and machinery,
businesses are allowed to deduct 25 per cent of the cost of the asset from the
(otherwise taxable) profit of the period during which the asset was acquired. In each
subsequent year of ownership of the asset, 25 per cent of the balance brought forward
may be deducted.