What is Capital Allowance And How Does it Work?

What is Capital Allowance

If you are managing a private limited company or you are self-employed, you might have heard about capital allowance and you also wish to reduce your tax liabilities. Are you wondering what is capital allowance and how it works?

Capital allowance is popular among businesses and yet it confuses many people in the United Kingdom. In this blog, we will help you by providing a comprehensive guide on this type of allowance for business assets. Moreover, we will walk you through the different types of this allowance and how it helps you lower your taxes on the taxable income.

So, let’s begin our informative discussion on this and you can decide how much you can get tax relief as a result of this!


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What is Capital Allowance?

Capital Allowance is given when a business incurs expenditures on the purchase of equipment, land and other assets for use in the business activities. Not all assets can qualify for this allowance. This allowance helps the taxable income to reduce after the capital allowance has been taken into account.

HMRC provides this allowance to the firms, organisations and self-employed people who are purchasing equipment, plant and spending on the activities of Research and Development (R&D) to grow their business.


Example of Capital Allowance

For example, if you buy a piece of machinery for £15 000 and you earn a profit of £100 000. In this case, your capital allowance is £15 000 and your taxable profits are £85 000.

Taxable Profits = £100 000 – £15 000

= £85 000

However, the terms may vary regarding the amount of allowance if it will be claimed in one year or over several years. Moreover, the HMRC also decides later if the full value or the partial value of the capital allowance can be claimed during a specific period.


Which Business Assets are Eligible for Capital Allowance Claim?

For claiming this specific tax relief in the form of an allowance, the assets have to qualify for criteria. The standard criteria are that you buy these assets to be used in the business. HMRC encourages businesses to make expenses on the assets to help thrive their business. This is the reason the organisations get tax relief in the form of capital allowance when they file their tax returns, ultimately lowering their taxable profits.

The following items can qualify for the Capital Allowance:

  1. Land
  2. Machinery (Cars, Vans, Trucks, Equipment)
  3. R&D
  4. Patents
  5. Renovations to Business Premises

However, the following assets cannot be claimed for capital allowances:

  1. Leased Items
  2. Buildings (doors, gates, shutters, water and gas systems)
  3. Land & Structures (Bridges, Roads and Docks)
  4. Business Entertainment Items (Boat and Entertainment Systems)


Types of Capital Allowance

A capital allowance has two main types and serves different purposes.

  1. Annual Investment Allowance (AIA)
  2. First-Year Allowance

Let’s discuss each of these two types separately!


Annual Investment Allowance (AIA)

Annual Investment Allowance (AIA) covers the full value of an item purchased. However, the claim is required in the same taxation in which an asset, machinery, land or equipment has been acquired. The gifts, cars, and used items before being used in this current company cannot claim Annual Investment Allowance.

A business can claim this allowance for assets up to the limit of £1 million in a taxation year. It is not necessary to cover the full expenditures of an asset under this allowance.


First-Year Allowance

Although this asset has no specific limit on the allowance claimed as it is the case in Annual Investment Allowance (AIA). However, this ‘Enhanced Capital Allowance’ is applicable only to the products contributing toward zero-carbon emissions.

In other words, only green products and assets can qualify for this allowance from the HMRC. On the other hand, water-efficient products can also come under this allowance category.


Writing-Down Allowances

Writing down allowances means you can claim partially the allowances in the next accounting period if you have not claimed the full relief on the eligible assets in the current accounting period. So, this process of carrying away the allowances to the next year is known as writing down the allowances.

It can be done for both Annual Investment Allowance and the First-Year Allowances. You can avail of this when the AIA allowance limit has been reached or you wish to take it for the items with no other deductions. For example, cars, assets received as gifts and items owned by someone else before using in your business.


Writing-Down Capital Allowance Rates

Following are the writing-down allowance rates you can enjoy in your taxable profits for the qualifying assets.

  1. The Main Rate  is 18% (General Pool)
  2. The Special Rate is 6% (Assets with Integral Features and long-life assets)

These rates are applicable only for specific items. Annual investment Allowance and First-Year Allowance 100% claim of the purchased items. However, they must also qualify for the specific items as it has been described above.


The Bottom Line

In the end, we would conclude that any expenditures on the business assets including buildings, machinery and vehicles are included in the capital allowance criteria. The other items received as gifts, pre-owned or leased items cannot qualify for this.

Annual investment allowance and First-Year Allowance provide 100% claim facility on certain items. However, you can spread over many years of the capital allowance by writing down it.


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Disclaimer: All the information provided in this article on What is Capital Allowance and How does it Work, including all the text and graphics, is general in nature. It does not intend to disregard any of the professional advice.