While the day to day running of your business might not be particularly expensive, it’s common to run into large purchases like machinery and equipment. These are known as capital expenditures, and capital allowances are a special tax relief that can help to soften the blow to your bank account.
Capital allowances are a little complex, so read on to find out more about the system and how to use it in your business’s tax returns.
What Are Capital Allowances?
Capital allowances are tax reliefs on purchases that are essential to running your company; for example, an espresso machine for your coffee shop. These purchases stay with your business as assets. It’s basically the opposite of your day-to-day running costs.
The main types of capital allowance are:
- annual investment allowance (AIA)
- first-year allowance (FYA)
- writing down allowance (WDA)
- balancing allowance (BA)
The first-year allowance allows companies in the UK to deduct 6% to 100% of the cost of capital expenditures made within the year the equipment was purchased. It’s a form of incentive for companies to invest in eco-friendly and innovative products.
It pays to know how to calculate deductions to help you save money to pay for your other business expenses or as savings to prepare for future expansion.
Annual Investment Allowance
Annual investments are often referred to as ‘plant and machinery’. AIA is the best-known capital allowance, and the two terms are often used interchangeably.
The Annual Investment Allowance (AIA) refers to a tax relief scheme for businesses in the UK designated for purchasing business equipment. Sole proprietors, partnerships, and corporations can claim this tax relief. Most assets you bought for business purposes are eligible for the AIA.
AIA allows you to deduct up to the full value of eligible items that are used solely for business purposes from your tax bill. The yearly allowance is £200,000 and the deduction must be made in the same tax year as the item was purchased.
First-year allowance has largely been phased out and replaced by AIA since the latter’s introduction in 2008, but it still applies to some energy-saving products like electric delivery vans. FYA allows you to deduct the full cost of items from your profits in the first year, provided the purchase qualifies.
It allows companies in the UK to deduct 6% to 100% of the cost of capital expenditures made within the year the equipment was purchased. It’s a form of incentive for companies to invest in eco-friendly and innovative products. In 2017, the government extended the allowance to three years for zero-emission vehicles and refuelling equipment in order to encourage their use.
Writing Down Allowance
Writing down allowance allows you to deduct a percentage of the value of an item from your profits each year.
There are basically two instances where you might use WDA: when you’ve reached the £200,000 allowance on AIA, or on assets that do not qualify for AIA or FYA. One example of the latter would be a company vehicle that is not emission-free. You can tailor the WDA claim. AIA isn’t mandatory to claim from the total amount of the expenditure. Claiming the AIA only applies in the time in which your business incurred the expenditure. After which, you can relieve any balance by claiming WDA.
The percentage deductible is either 18% or 8%, depending upon the asset itself. Visit HMRC for a helpful guide to rates and pools for writing down allowances.
Balancing Charges and Allowance
A balancing allowance pertains to a form of capital allowance given under multiple allowance codes, which applies to asset disposal or when the business closes. Balancing allowance rules differ between different codes of allowances. No balancing allowances apply under building or structure codes and research and development codes. For machinery and plant code, a balancing allowance occurs in a pool of expenditure in the pool’s final chargeable period.
Balancing charges cover depreciation on assets that are being sold or otherwise disposed of. For example, if you purchased an espresso machine for £5,000 and sold it for £4,000, your balancing charge would be £1,000. The balancing allowance is simply this on a larger scale; it applies to businesses that have ceased trading.
Does My Business Qualify for Capital Allowances?
The majority of British businesses can claim capital allowances. This includes sole traders, companies and individual partnerships.
Trusts and mixed partnerships – that is, partnerships that are made up of companies and people – are specifically not allowed to claim annual investment allowances. This is to prevent large companies from setting up businesses specifically to avoid tax. These businesses can still claim writing down allowances at the lower rate of 8%.
What Can I Claim Capital Allowances For?
You can claim capital allowances against assets like equipment, machinery and vehicles.
HMRC’s definition of plant and machinery is rather nuanced, but as a rule of thumb, large purchases that are essential to the running of your business are covered, while repairs and alterations are not.
Some alterations do count. For example, you might find that you need to knock down a wall or replace a ceiling in order to install air conditioning; in this case, you’ll be able to claim capital allowances on both the air conditioning system and the alterations.
Remodelling premises can sometimes count, provided the work enables you to run your business.
Other than physical assets, you can claim capital allowances on tools such as patents and research and development.
What Can’t I Claim Capital Allowances For?
Some examples of assets that are not eligible include:
- things you lease; you must own the assets outright
- buildings, including doors, gates, shutters, mains water and gas systems
- land and structures, such as bridges, roads and docks
- items used only for business entertainment, and not for trading
- items that it’s your trade to buy or sell, i.e. shop stock
- regular expenditure such as accountancy fees
- interest payments or finance costs on assets
While you can’t claim capital allowances on your trading premises, some parts of a building are considered ‘integral features’. These include lifts, lighting and air conditioning systems.
HMRC also allows some fixtures towards your allowance. These include fitted kitchens, bathrooms, fire alarms and CCTV systems, but you must have purchased them yourself.
Can I Claim Capital Allowances on Second-Hand Equipment?
Second-hand equipment is already taxed and devalued, so you might wonder whether you can claim relief on it. Surprisingly, you can. In the eyes of the law, the history of the item doesn’t matter, as long as you have purchased it and it is new to your business. You simply need to provide evidence of the amount you paid.
How Does VAT Work With Capital Allowances?
If your business is registered for VAT, you might be wondering how to calculate deductions. It’s simple: the net cost is the amount that qualifies for allowance. If you are not VAT registered or exempt, the full price including VAT applies.
How Do Capital Allowances Compare to Cash Basis Expenses?
If you are a sole trader or partner with an income of £150,000 or less, you might already be using the cash basis system instead of traditional accounting. Cash basis is much simpler, and all of your expenses are handled as standard business expenses. That means you can’t claim capital allowances.
Cars are the exception: you can claim writing down allowances with the rate depending upon the car.
What About Purchases That Aren’t Covered by Capital Allowances?
You can claim expenditure that isn’t covered, like repairs and maintenance, as business expenses if you are a sole trader or partner. If you own a limited company, deduct these costs from profits as a business cost.