A complete guide to capital allowances

When filing taxes, it’s important to be aware of all the different types of business deductions. One key category for UK businesses is the capital allowance. This is HMRC’s way of offsetting depreciation for businesses of all sizes. Here’s what you need to know about the capital allowance.

What is a capital allowance?

Capital allowances are any expenditures that a business can claim against its profits for tax purposes, as outlined by the Capital Allowances Act and regulated by HMRC. Allowable expenditures include most assets purchased for business use, such as office renovations and equipment.

Capital allowance expenditures should be reported to HMRC on your business tax returns. Some allowances can be deducted in the year the expense is incurred. Other types of allowable spending are spread out over multiple tax years.

Capital allowances definition: What qualifies?

Not all business expenses qualify as capital allowances. To qualify, the expenditure should be for the business’s lasting benefit, typically longer than one year at minimum. For example, everyday office supplies wouldn’t qualify for capital allowances tax deductions, but longer-lasting machinery would. Typical categories of expenditure include:

• Business equipment, including manufacturing and office machinery

• Company vehicles, including cars, vans, and lorries

• Research and development costs

• Patents

• Renovations to business premises

Along with short-term expenses like office supplies, you cannot claim leased items, buildings, land, or structures as capital allowances. Business entertainment items also do not qualify for this type of deduction.

Types of capital allowances

There are three main types of capital allowances. This includes first-year allowances, annual investment allowances (AIA), and writing down allowances:

First-year allowance

This type of deduction is applicable only in the first year of an item’s purchase. To qualify, purchases must meet the government’s efficiency requirements. Examples would include zero-emissions trade vehicles, water-saving equipment, or company cars with low carbon emissions. The purpose of first-year allowances is to encourage businesses to invest in energy efficiency.

When you purchase an asset qualifying for the first-year allowance, the full cost can be deducted from business profit before tax.

Annual investment allowance (AIA)

With the AIA, businesses can deduct the full value of assets used entirely for business purposes. At present, the annual limit is £1 million. Expenditures claimed under the AIA must be declared in the same tax year that the asset was purchased. This type of capital allowance typically includes machinery and factory equipment.

Writing down allowance

It’s also possible to spread your allowances across several years using the writing down allowance method. This is used for any assets that don’t fit into the other two categories. Examples would include items you purchased prior to starting your business but which are now used for business purposes. Gift items and cars also fall into this category. With writing down allowance, the deduction is spread out over time.

Writing down allowances are also used when a business has already claimed AIA and has exceeded the AIA threshold.

Capital allowances rates

Your capital allowances calculation will depend on the type of item and allowance. When spread out over time, as in the case of writing down allowances, most items qualify for an annual deduction equalling 18% of their value. Some will only be eligible for a rate of 8%, including less-efficient assets or long-life assets.

Capital allowances calculations start with the value at the time of purchase, which in most cases, is the price paid. However, market value is used in the case of previously owned items or gifts.

Capital allowances tax rules for automobiles

When vehicles are purchased for sole business use, they may or may not be eligible for the capital allowance.

In most cases, cars fall under the plan and machinery category. Low-emission vehicles garner a 100% first-year capital allowance, allowing you to write off the entire cost against taxable profits. Higher emission vehicles incur capital allowance rates of either 18% or 8%, depending on the efficiency rating.

For limited companies, employees may be liable to pay tax on the vehicle if it’s considered a ‘benefit in kind.’ However, in the case of sole traders or partnerships, the vehicle wouldn’t be eligible as a capital allowances tax deduction because there isn’t a distinction between the business and the individual.

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