ACCA Advanced Taxation (ATX) Practice Exam

What is the significance of a balancing adjustment in capital allowances?

1. It reflects the total assets of the business

2. It adjusts the capital allowance to nil upon cessation

3. It ensures fair capital gains assessment

4. It influences company tax residency status

The correct answer is: It adjusts the capital allowance to nil upon cessation

The significance of a balancing adjustment in capital allowances lies primarily in the treatment of capital allowances when an asset is disposed of or when a business ceases to operate. When a business sells an asset or ends its operations, the balancing adjustment is necessary to ensure that the capital allowances already claimed on the asset are taken into account. If the proceeds from the sale of the asset exceed the tax written-down value (i.e., the current value of the asset for tax purposes after the capital allowances have been claimed), a balancing charge may occur, which effectively means that the business must add back some or all of the previously claimed allowances into its taxable income. Conversely, if the proceeds are less than the tax written-down value, a balancing allowance can be claimed, reducing the overall taxable income. Thus, the balancing adjustment is essential to provide a correct and fair treatment of income and expenses related to capital assets, especially during the cessation of a business's trading activities. This ensures that there is no double taxation or unwarranted benefit from claimed allowances over the life of the asset.