Capital allowances are a form of tax relief when your business buys a capital asset such as machinery, equipment or vehicles. They are regarded as a business expense, and you may be able to deduct some of the cost away from your profit before working out the tax you owe.
What are Capital Allowances?
Capital allowances are a form of tax relief relating to the purchase of assets that are large investments and not considered to be day-to-day running costs of your business. Normally this asset will have to be owned for a longer period, is necessary for you to carry out your work and will benefit your business in some way. Capital allowances may apply to tangible and intangible capital assets.
You can claim capital allowances on certain assets bought for your business. These business expenses fall under the category of plant and machinery:
- Pieces of machinery such as refrigerators or plant machinery
- Equipment such as hardware or other devices that are required for running a business
- Business vehicles such as vans, cars or lorries which are used to run a business
It is also possible to claim for capital allowance on expenses other than plant and machinery including:
- Research and development
- Renovating business premises in disadvantaged areas of the UK
- Patents and know-how
- Extracting minerals
Can you claim Capital Allowance on all expenditures?
Unfortunately, no – the expenditure must be on certain assets. A full list of what qualifies can be found on the government’s website.
How do I claim Capital Allowances?
Capital allowances are claimed as part of your tax return. How you claim differs depending on how you operate your business:
- Limited company – via a company tax return and a separate capital allowance calculation
- Sole trader – via a self-assessment tax return
- Partnerships – via a partnership tax return
You must claim Annual Investment Allowances (AIA) and first year allowances in the same tax year you bought the asset.
What is a first year allowance?
Launching a new business can be expensive, and costs can quickly build up within the first year when plenty of purchases need to be made. The first year allowance is aimed particularly at new small to medium-sized businesses and allows them to deduct between 6% and 100% of the cost of the qualifying capital expenditure made during the year the equipment was purchased.
You can claim first year allowances alongside your AIA, and they do not count towards the AIA limit. Assets that qualify for the first year allowance are deducted from your profits before any tax contributions.
To find out what qualifies for the first year allowance and how to claim it visit the government’s website.
What is the Annual Investment Allowance?
The AIA allows you to deduct the full cost of eligible assets from your profits before you work out your tax; this is subject to the annual maximum and excludes cars. The annual maximum for AIA has temporarily increased to £1 million between 1 January 2019 and 31 December 2020. You can claim AIA on most plant and machinery. More information about AIA and what you can claim can be found on the government’s website.
The AIA limit is renewed with each new accounting period. If you go over your AIA allowance it is possible to claim writing down allowances on eligible assets and spending.
What is a writing down allowance?
The writing down allowance (WDA) can be used when you purchase business assets. It enables you to deduct a percentage of the value from your profit each year to allow you to claim tax relief.
The writing down allowance can be used if you have already reached your annual investment allowance limit for the year, or the item you want to purchase doesn’t qualify for AIA.
You will group items you have bought into pools based on the percentage rate they qualify for. This allows you to claim tax relief based on that pool, carry the remaining cost forward each year and continue to apply for tax relief until it is paid off.
What are the different pools and percentage rates for writing down allowances?
- Main pool rate – 18%
- Special pool rate – 8%
- Single asset – varies between the two rates depending on what the item is
For more information on how to work out which asset qualifies for which pool visit the government’s website.
What happens when you put assets into a pool for a writing down allowance?
You should group items you’ve bought into the above pools based on the percentage rate they qualify for.
For example, imagine you’ve bought a piece of equipment which costs £210,000. It qualifies for the main rate pool (18%) – so you can claim 18% of its costs (£1,800) in the first year. That leaves £8,200 of the cost of the item which is still to be paid.
The remaining amount of £8,200 becomes the starting balance for the pool for the next accounting period. The written down value brought forward would be £8,200 – you can claim another 18% tax relief for the written down allowance on this item and continue to do so each year until the item or pool has been paid off.
What is the small pools allowance?
Once you have £1,000 or less in either the main pool or special rate pool you can claim a capital allowance called the small pool allowance on the full amount. The small pools allowance cannot be claimed in conjunction with the writing down allowance.
Always use a knowledgeable and trustworthy accountancy provider
A knowledgeable accountancy provider such as Churchill Knight & Associates Ltd will stay up to date with all the latest industry regulations and ever-changing laws that affect contractors. We will be able to correctly advise you on the most legally tax-efficient way of drawing money from your business and what tax relief you are eligible for.