Interestingly, while the UK government has imposed different taxation on different industries, it also facilitates businesses by permitting them to deduct the allowable expenses and allowances to cut down their tax bill. One such tax-deductible allowance is a capital allowance. This guide covers all crucial aspects of what is the capital allowance for self-employed individuals to ensure they maximise tax relief and maintain financial efficiency.
Capital allowance is a form of tax relief that allows businesses, including self-employed individuals, to deduct the cost of qualifying or eligible capital assets from their taxable profits. Thus, it is a considerable financial benefit for sole traders to significantly reduce their tax liability.
Get in touch with our young, clever, and tech-driven professionals if you want to choose the solution to tax burden or accounting problems in the UK for your income. We will ensure to offer the best services.
What is the capital allowance for self-employed?
While being self-employed brings immense autonomy or freedom in how you run your business, it also entails managing and taking on all the challenges, responsibilities, and expenses single-handedly.
For instance, you will essentially make the investment in the equipment or tools to conduct your business trade, such as computers, machinery, or lorry. Undeniably, purchasing such heavy and high-priced equipment would be no small feat, particularly for self-employed-run small businesses.
It is noteworthy that HMRC has termed such expensive business equipment as plant and machinery for tax purposes.
You must be wondering where the relief is then.
To your relief, the answer lies in the capital allowance.
Fortunately, every investment a self-employed worker makes in their business-related essential tools comes under the qualifying equipment for tax relief, according to HMRC. These equipment are referred to as capital assets and their taxation is different compared to other allowable expenses.
Speaking of allowable expenses for self-employed, you can learn what they are and how you can claim them to trim down your taxes with our comprehensive guides:
How to save taxes as self-employed workers?
What are allowable expenses for self-employed people in the UK?
Coming back to capital assets, when you purchase them and utilise them exclusively for your business, HMRC will class them as capital assets for which you can claim capital allowances. Consequently, by claiming the capital allowance on your capital assets, you can effectively deduct the entire or some of their value from your profits to cut down your tax bill.
More importantly, claiming a capital allowance makes it easier for small business owners, like sole traders, to invest in necessary business equipment, machinery, and other capital assets. Above anything else, capital allowances distribute the deduction over multiple years, similar to asset depreciation, rather than deducting all the expenses in one tax year.
Furthermore, HMRC provides various types of capital allowances, each with its own set of rules and qualifying criteria. Hence, there is a limit to how much you can claim back, which is known as your capital allowance or Annual Investment Allowance (AIA).
What are the types of capital allowance for self-employed individuals?
Coming to grips with the types of capital allowance is a crucial part of learning what is the capital allowance for self-employed workers.
HMRC provides different categories of capital allowances, including:
Annual Investment Allowance (AIA):
Under the Annual Investment Allowance (AIA), businesses can deduct 100% of costs on qualifying plants and machinery up to a specified limit in the same tax year. For greater clarity, AIA empowers you to deduct the full cost of plant and machinery from your profits before you pay any tax.
Thus, the AIA is a 100% capital allowance for the eligible plant and machinery that you purchase. Surprisingly, the AIA limit for 2024/25 has been increased from £200,000 to £1 million. Subsequently, you can claim up to £1 million for qualifying assets.
For more details, you can visit the government website. Notably, the qualifying assets for AIA include machinery, equipment, office furniture, and commercial vehicles (but not cars).
Three are a few key considerations about an Annual Investment Allowance that a self-employed worker must remain mindful of:
- Although HMRC allows you to claim a new allowance for each accounting period, you can only claim in the period you bought the object.
- Likewise, to claim the entire value of the items, it is mandatory that you only have used them within the ambit or scope of your business since any equipment used outside your business for private reasons will not qualify for AIA for a self-employed worker.
- Next, while you can claim 100% expenditure on the qualifying asset with AIA, it might be subject to tax if you sell it at a later point in time.
- For a self-employed worker or someone who is a member of an ordinary partnership with many businesses or trades, each business can typically claim AIA. However, there will be certain limitations if they are governed by the same person, have similar activities or are managed from the same premises.
- Mixed partnerships are not entitled to or qualify for AIA.
Writing Down Allowance (WDA)
In brief, for assets that either do not qualify for AIA or exceed the AIA threshold, the Writing Down Allowance (WDA) can be applied to them.
In detail, the costs or expenditures of the assets that are not eligible for annual investment allowance (AIA) are pooled together, which is called the general pool. With WDA, you can claim tax relief on the assets’ value contained in the pool.
It is worth pointing out that for the tax year 2024/25:
WDA’s main rate pool is the normal WDA of 18%, which applies to the expenditure of most plants and machinery in the general pool. Similarly, there is also a special rate pool of 6%, which applies to long-life assets, integral features, and certain cars.
Luckily, WDA spreads tax relief over several years instead of deducting the full cost in one tax year.
AccountingFirms makes it seamless to search for the best fit for your accounting and taxation needs by applying filters and getting the most customised result. Let’s hire the best accountant now!
First-year Allowances (FYA):
As the name suggests, First-Year Allowances (FYA) offer 100% tax relief in the first year. However, only specific assets can qualify for FYA, for which you can deduct the full cost from your profits before tax, given they are in brand-new condition. Interestingly, you can claim both the AIA and first-year allowances simultaneously.
The prime purpose of the UK government to launch this allowance is to encourage environmentally friendly investments.
A few examples of the qualifying assets for the first FYA include:
- Zero-emission vehicles, like electric cars;
- Zero-emission goods vehicles;
- Plant and machinery for petrol refuelling stations, such as storage tanks, pumps, etc.
- Energy-efficient equipment;
- Water-saving machinery.
Conclusion:
In the end, understanding what is the capital allowance for self-employed is vital as it helps reduce taxable profits, which in turn maximises tax savings. Moreover, self-employed individuals must ensure compliance with HMRC regulations to claim accurate capital allowance deductions and potential tax penalties.
Otherwise, a certified and skilled accountant registered with Accountingfirms can prove an immense help in maintaining proper and accurate records as well as staying informed about Making Tax Digital (MTD) requirements. As an outcome, with the help of a financial expert, self-employed individuals can witness tax optimisation and effective reduction in tax bills.
Moreover, since this guide revolves around self-employed individuals, you can gain an in-depth understanding of what self-employment entails by reading our following guides respectively:
Everything you must know about what is self-employment.
What are the advantages and disadvantages of being self-employed?
What are the types of self-employed in the UK?
Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.