Investing in your business can be extremely expensive. However, the relief afforded by capital allowances can significantly help to increase your cash flow.
That said, it is not uncommon for businesses to underestimate the proportion of their expenditure that qualifies for capital allowances. This means you may be paying too much tax.
Below we look what type of expenditure qualifies for capital allowances and who can benefit.
What are capital allowances?
Capital allowances are a form of tax relief for businesses. These allowances allow you to deduct some or all of the value of qualifying expenditure from your profits before you pay tax.
Capital expenditure on plant and machinery is the most common type of investment giving rise to relief by way of capital allowances. This can include things like computers and office equipment, tools and specialist machinery, and motor vehicles, although special rules apply to cars.
Plant and machinery also generally covers all fixed assets used in a business, although you can’t claim capital allowances on actual buildings and land. You can, however, claim for integral features such as lifts and escalators, space and water heating systems, as well as electrical and lighting systems.
However, the potential for tax relief is even broader than this. Capital allowances can apply to a wide range of expenditure, where businesses across the UK are failing to take full advantage of the available relief.
What type of expenditure qualifies for capital allowances?
In addition to plant and machinery, qualifying capital expenditure can include things like research and development, patents and know-how.
The investment made by businesses in, for example, research and development, can often be significant. Moreover, where this qualifies as expenditure under the capital allowances rules, the tax relief can make a real difference.
Note, that to qualify for capital allowances you must normally own, rather than be leasing, the asset as a result of incurring the expenditure.
However, for costs that do not qualify under the rules, you can very often claim for these in a different way. This will include your day-to-day running costs or items that you buy and sell in the course of your trade.
If you are a sole trader or partner you will need to claim these costs as tax-deductible business expenses, or deduct this expenditure from your profits as a business cost if you are a limited company.
Who can claim capital allowances?
To claim capital allowances you must be a ‘qualifying person’. This must be an individual, a partnership of which all the members are individuals, or a company, that has not inly incurred the qualifying expenditure but is carrying on a ‘qualifying activity’.
A qualifying activity can include trades, professions or vocations, property or special leasing businesses, as well as employments and offices.
As with qualifying expenditure, the range of qualifying activities is very wide. It broadly covers all taxable activities other than passive investment.
What are enhanced capital allowances?
Under the Enhanced Capital Allowances (ECA) scheme, businesses can benefit from tax breaks when investing in eligible energy-saving equipment and technologies.
This includes energy-saving plant and machinery, low or zero emission cars and goods vehicles, natural gas and hydrogen refuelling infrastructure, and water conservation plant and machinery in construction projects.
In the case of energy efficient investments, you can deduct 100% of the cost of a qualifying ECA item from your pre-tax profits. This provides significantly increased savings over other types of capital allowances because of the environmentally beneficial nature of the asset.
The net effect of is that you can write off the entire cost of purchasing an energy or water efficient product against your taxable income in a single tax year.
However, a new government proposal due to come into effect in April 2020, is likely to see an end to enhanced capital allowances for energy and water efficient plant and machinery. The time to invest is therefore now.
How do I qualify for enhanced capital allowances?
To qualify for enhanced capital allowances you must have incurred the relevant expenditure on a qualifying item, you must own rather than be leasing the item, and at least have it installed ready for use.
Only new plant and machinery are eligible for enhanced capital allowances, where used or second-hand plant and machinery do not qualify.
You will be able to claim ECA relief only if you invest in a listed product meeting the energy-saving or water conservation criteria specified by the Carbon Trust at the time of purchase.
What is the annual investment allowance?
The annual investment allowance provides 100% relief for qualifying expenditure. This means that up to this limit you can deduct the full cost of any capital expenditure from your profits before tax.
It is only where you spend more than the annual limit that you will need to rely on the additional relief provided by capital allowances. However, you can claim enhanced capital allowances in addition to your annual investment allowance, whereby they don’t count towards your limit.
From January 2019, the annual investment allowance for businesses has increased significantly from £200,000 to £1 million.
However, this increase is only a temporary 2-year measure aimed at helping businesses to invest and grow in the current political and economic climate. As such, if you are looking to invest in your business, now is the time to do it.
How do I calculate any capital allowances?
In circumstances where you have exceeded your annual investment allowance, or the item doesn’t qualify under the rules, the writing down allowance can be applied instead.
This allows you to gradually set expenditure against tax in subsequent accounting periods, although the amount of the deduction depends on the item. You are able to do this at any time provided you still own the qualifying item, although it offers much less attractive rates.
The main rate is currently set at 18%, and the special rate at 8% per year.
How do I claim capital allowances?
If you are a sole trader or partnership you will need to claim any capital allowances using your self-assessment or partnership tax return.
For your annual investment allowance and any enhanced capital allowances you must claim in the same tax year that you made the capital investment.
You can claim enhanced capital allowances in addition to your annual investment allowance, whereby they don’t count towards your limit.
If you use the cash basis rather than the traditional accounting method to calculate your trading profit, with the exception of cars, all other expenditure must be claimed as tax-deductible expenses rather than as capital allowances.
Key takeaway for capital allowances
Capital allowances are a relatively easy way for a business to make significant tax savings and improve its cash flow through accelerated tax relief.
By understanding what constitutes qualifying expenditure and what this means in terms of tax savings can make a real difference to your business.
Moreover, the recent introduction of the £1 million annual investment allowance means that many businesses will benefit more than ever before from the tax advantages that come with capital allowances.
Beware, therefore, not to miss the narrow window of opportunity to invest in your business and benefit from the new increased annual investment allowance.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal or financial advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal or other advice should be sought.