Capital allowances allow you to claim tax relief on assets you buy for your business. The value of these items can be offset against your company’s profits over time. So how do capital allowances work in practice?
Day-to-day expenses vs. capital expenditure
The day-to-day expenses you incur running your business are typically offset against your company’s profits and can be claimed without delay as expenses.
However, not all costs are ‘allowable’ as day-to-day expenses for tax purposes – typically larger ‘capital’ items. They are accounted for in a different way.
As the cost of depreciation is not allowable for tax purposes, HMRC provides a system of capital allowances to help businesses write off the value of assets over time in a uniform way. This may be over several accounting years – with a proportion of the value of each asset being written off against profits.
For the sake of completeness, this guide provides an overview of capital allowances for a range of small companies, in addition to a typical contracting business.
Tax relief on business equipment
Capital assets include items you buy to use in your business such as equipment, machinery, and cars or vans for business purposes. You can deduct part or in some cases all of the value of these items from your profits before paying tax.
For instance, if you’re starting a new contracting company, you can claim for the purchase price of a new computer or server for use in your business.
If you already owned the computer before starting your company or received it as a gift, you can claim for the market value of the item (what you’d expect to get if you sold it).
Other types of capital expenditure may also qualify for tax relief under one of HMRC’s capital allowance schemes.
Benefits of Capital Allowances
Apart from getting tax relief on the value of the equipment you buy for your business, capital allowances can also be an incentive to invest in your local area. For instance, if you decide to set up and renovate your business premises in a disadvantaged part of town, you may be able to claim tax allowance of 100%, provided the works you carry out qualifies under the scheme.
Capital Allowance schemes
The four main types of capital allowance schemes which can help to cut your annual tax bill are:
- Annual Investment Allowance (AIA)
- Writing Down Allowance (WDA)
- Research and Development Tax Relief
- Enhanced Capital Allowances (ECA)
We’ll look at these in more detail below but first, it’s worth pointing out that if you’re a small company turning over less than £150,000 a year, it might be simpler to claim tax relief using HMRC’s ‘cash basis’ system.
Claim for ‘plant and machinery’ using AIA
Items you purchase for use in your business are defined as ‘plant and machinery’ and covers not just equipment but certain type of costs as well. You can deduct the purchase cost of qualifying items from your profits using AIA.
So what comes under ‘plant and machinery’?
- Computers, office equipment, office furniture
- Fibre optic cabling, wiring
- Shop fittings and fixtures
- Integral features of buildings such as lifts, air-conditioning, electrical systems
- Alterations to a building to make room for new equipment
- Demolition of old or redundant plant and machinery
- Agricultural equipment
- Cars, although you have to claim for these using the Writing Down Allowance
What isn’t considered ‘plant and machinery’?
- Equipment or items that are leased
- Equipment used for business entertainment only such as a gaming machine or speedboat
- Land and structures such as gates, bridges and roads
- Buildings and features such as doors and shutters
The AIA expenditure limit was increased from £200,000 to £1m during 2019 and 2020. The £1m will also be maintained throughout 2021.
Claim using WDA
As stated above, the majority of assets you buy for your business can be claimed for using AIA but you should claim using WDA instead in the following instances:
- Where the items or equipment doesn’t qualify for AIA, including cars, items you owned before you set up the company and/or gifts of items you use in the business
- Where you’ve already claimed for an item that exceeds the AIA amount (see below)
Using WDA, you deduct a percentage of the value of the item (depreciation) from your profits for a tax year. The percentage will depend on the item, for instance, the CO2 emissions of your car. For guidance on working out your allowance, see here.
Claim using ECA
If you buy energy-efficient plant and machinery such as a zero-emissions vehicle, water-saving equipment or other items that appear on HMRC’s energy technology product list, you can claim tax relief using ECA. For an up-to-date list of the type of equipment that qualifies, you can find out more here.
Claim for research and development (R&D)
Tax relief here is intended to support businesses and SMEs carrying out R&D and working on innovative projects. The project itself doesn’t have to succeed in a commercial sense to qualify for a tax break. To check if your project qualifies, see here. You can also ask HMRC for a guarantee your R&D claim will be accepted by applying for ‘advance assurance’.
The amount you can claim using AIA or any of the other schemes can and does vary so always check on the HMRC portal (or more likely, your accountant) for the latest figures!
For obvious reasons, given the complicated nature of capital allowances, you should discuss any questions you may have with your own accountant.