Understanding Capital Allowances for Small Business

Capital allowances or plant and machinery allowances are a form of tax relief available to businesses in the United Kingdom, providing a means to lower taxable profits and, in turn, reduce tax liabilities. Essentially, they allow businesses to write off the cost of certain capital assets against their taxable income.

Capital allowances for small business guide

These assets may include tangible fixtures and fittings, machinery, or commercial vehicles that are part of the operation of the business. By understanding and correctly applying capital allowances, businesses could save their overall tax bill significantly.

How Capital Allowances Reduce Taxable Profits

When a business invests in a capital asset, let’s say, a new piece of machinery for production, the cost of this asset can be factored into their financial calculations as a capital allowance.

It is similar to how we might deduct expenses. Instead of the business having to pay tax on the full amount of their profits, they deduct the capital allowance of this machinery. Therefore, the profit figure that they pay tax on, the taxable profit, is effectively reduced.

This is how capital allowances work to decrease a business’s taxable profits, potentially leading to considerable savings on the tax bill.

Examples of Capital Allowances

As mentioned, capital allowances can be claimed on a range of tangible assets used for business purposes. Some common examples include:

  • Plant and machinery allowances
  • Commercial vehicles
  • Cars
  • Computers
  • Fixtures and fittings
  • Office equipment
  • The cost of alterations for a building
  • Solar panels

This list is not exhaustive, however, as businesses may also claim capital allowances on other categories of assets, such as energy-saving equipment and certain types of buildings.

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Different Capital Allowances for Plant and Machinery (P&M)

When it comes to claiming P&M allowances, there are several categories:

Annual Investment Allowance AIA

This allows businesses to claim a 100% tax relief for up to £1 million of investments in plant and machinery each year.

Writing Down Allowance WDA

When the value of an asset is over the AIA threshold, businesses may be able to claim a writing-down allowance of 18% (6% if a special rate applies) on the balance.

100% First Year Allowance FYA

Certain environmentally friendly technologies may qualify for a 100% first-year allowance on investments up to £1 million. This allowance allows businesses to write off the entire cost of their investment in one go rather than over several years.

How to Claim Capital Allowances

Capital allowances are not recorded automatically as a business; you need to claim tax relief for them. To do this, it is vital that you are aware of the allowances available and that you keep accurate records of your capital purchases.

For claiming capital allowances, we recommend you use the services of an accountant or bookkeeper with experience in the area to ensure that you are making full use of the reliefs available and ensuring HMRC compliance.

It is crucial to keep detailed business records, especially for capital purchases, as these will be needed when completing your tax return or if an inspection by HMRC takes place. You should keep all supporting documents, such as quotes, invoices, and receipts so that you can prove the cost of your capital purchases.

You should also ensure that you keep up to date with any changes in legislation that may affect your ability to claim capital allowances, as well as any other taxation matters which could affect the profitability of your business.

Limited Companies

Limited companies claim capital allowances using their company corporation tax return. Taxpayers must add up the total cost of qualifying assets, claim the relevant allowance and deduct it from their taxable profits.

Partnership

Capital allowances are claimed on the partnership tax return if you are in a partnership.

Self-Employed

Each year, Self-employed complete a self-assessment tax return. Capital allowances can be claimed on the self-assessment tax return by deducting the cost of qualifying assets from their taxable profits. There is a section on the form to complete.

Capital Allowances for Business Cars

Business cars are another category of asset that may qualify for capital allowances. Business car allowances allow businesses to write off some or all of the cost of their vehicles against their taxable profits.

Cars do not qualify for the annual investment allowance but are calculated using the writing-down allowance. There are exceptions for electric vehicles where the 100% first-year allowance is used.

There are three different rates for cars. Your rate will depend on the CO2 emissions and when the vehicle was purchased. The rates are:

100% for certain cars under first-year allowances

18% of the car’s value for the main rate allowance

6% of the car’s value for special rate allowances.

Capital Allowances and Disposals

If you dispose of capital assets, you may need to adjust your capital allowance claim or pay a balancing charge. This is known as a ‘capital allowances balancing charge’.

When you sell an asset that has been written off using capital allowances, you must work out the amount of profit or loss made on the sale. If there is a gain, then this will be added to your taxable profits and taxed accordingly. If there is a loss, then this can be deducted from your taxable profits.

It is also important to declare these transactions on your tax return or inform your accountant.

Capital Allowances Examples

For example, a business invests in some new machinery for £25,000. If this qualifies for capital allowances, then the business could claim the AIA and deduct the entire purchase cost in one go from their taxable profits. This would reduce their overall tax bill for that financial year.

Alternatively, if a business invests in a car for £20,000 that is eligible for capital allowances, they could claim the writing-down allowance and deduct 18% of the cost each year from their taxable profits.

In both cases, it is essential to keep detailed records of all capital purchases and disposals to ensure that any claims are correct.

Writing Down Allowances Rates and Pools

Writing-down allowances are allocated to a pool of assets, and the rate at which they can be claimed is determined by the type of asset.

To work out how much you can claim in each pool, you will need the following:

  • The opening balance
  • Add any new capital expenditure
  • Deduct any items that were sold in the period.
  • Calculate the rate for the pool and deduct it.

An example is a business that has an 18% standard rate pool with an opening balance of £5000; during the year, they add £1000 of qualifying expenditure items and dispose of £500. At the end of the year, the pool is £5500 less 18% (£990). The closing pool value is, therefore, £4,510.

If the remaining pool is less than £1000, you can claim the total amount as a small pool allowance.

Depreciation and Capital Allowances

Depreciation is used on the balance sheet to write the cost of capital expenditure over its useful life. Depreciation is excluded when calculating business tax, so it does not reduce the amount of tax that you pay.

Capital allowances are used to calculate taxable profits and can reduce your overall tax liability.

Capital Allowances FAQ?

What if I don’t want to claim for full capital expenditure?

You can always claim less than the full amount of capital expenditure or use the writing-down allowances instead. If you do this, keeping accurate records and informing HMRC about your decision is important.

How much can I claim if the Capital Expenditure is used Outside the Business?

If the capital expenditure item is used outside the business, you will need to adjust your tax return for the amount used outside the business. For example, a sole trader purchased a laptop for £800 but used 25% for business use. The qualifying capital expenditure is 75% of £800, so £600 can be claimed.

Can I claim Captial Allowances on leased items?

No, leased items are not eligible as the business does not own them. Instead, you will claim it as a business expense.

Is there a limit to how much I can claim in Capital Allowances?

The amount of capital allowances you can claim depends on the type of asset. For example, the Annual Investment Allowance (AIA) allows businesses to claim up to £1 million of investments in plant and machinery each year.

Do I have to use all of my Capital Allowances?

No, if you don’t think you will need your full allowance for a particular tax year, then there is no requirement that you have to use it all up. It is sometimes best to use your allowances in stages rather than all at once, as this can help spread out the costs and ensure that you are using them efficiently.

Are there Buildings Allowances Available?

Yes, there is, but buildings are treated at a lower rate of 3% from April 2020.

Capital Allowances Conclusion

Capital allowances are a great way for businesses to reduce their tax liability. They are relatively simple to claim as long as you keep accurate records of your capital purchases and ensure all claims comply with HMRC regulations. It is also essential to stay up to date with any changes in legislation so that you can take full advantage of the reliefs available.

Capital allowances can be a complex area, and it is recommended that you seek the advice of an accountant or bookkeeper with experience to ensure that your business is making full use of the reliefs available. This will help ensure your business remains profitable and compliant with HMRC regulations.