Capital Allowance

Capital allowances (also known as Tax allowable depreciation) replaces accounting depreciation of capital assets while computing taxable profits/losses.  

HMRC provides a set of rules and a mechanism to calculate capital allowances (Tax allowable depreciation). The amount is deducted from trading profits or losses to arrive at the taxable profit or losses number. 

The capital allowances aim to encourage investments in capital assets. It improves businesses' cashflow position by decreasing outflows fro tax payments, especially in earlier years of capital investments. 

As the name suggests, capital allowances are for capital expenditure only and available to all self-employed, sole traders, partnerships and limited companies.  

What qualifies under capital assets? 

As directed by the HMRC, all assets acquired for use in trade are eligible for capital allowances except Land. 

More commonly claimed capital allowances are: 

  • Plant and machinery  
  • Pieces of equipment  
  • Vehicles  
  • Computers and laptops 
  • Furniture and fittings 

Benefits of claiming capital allowances 

  • Reduced taxable profits hence lower tax meaning more taxable profit/loss 

How to claim capital allowances? 

You can claim all types of capital allowances on your annual tax return.  

Types of Capital allowances: 

  1. Annual Investment Allowance (AIA) 

It is the KING of all capital allowances. Under AIA, you can claim 100% tax relief (up to AIA limit) on items of plant and machinery purchased in a financial year. Many assets fall under this arrangement except cars. 

Example: 

You buy an item of plant and machinery for use in your business called Beta Ltd. 

  • The machine costs £5,000  
  • The business's profit is £20,000 
  • In this case, you can claim an AIA, which would be the cost of your machine. You can subtract it from the total profit, i.e. £20,000 - £5,000 = £15,000.  
  • So now this is the taxable profit on which you will be paying corporate tax @ 19%, i.e. £2,850. 

Annual allowances have a limit. It is usually £200,000 but temporarily increased to 1 million until 01 January 2022. 

You can read more about AIA here 

  1. First Year Allowance (FYA) 

 First-year allowances encourage business owners to invest in qualifying energy-efficient equipment.  

FYA do not count towards your AIA limit so that you can claim FYA in addition to AIA. 

You can claim this allowance within the first financial year of the purchase of an asset.  

You usually cannot claim FYA on items bought and leased or used within a buy to let home  

  1. Writing down allowance s 

You can claim writing down allowance for all those assets not qualifying for AIA or FYA like motor cars.  

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