Understanding the rules for capital allowance and how those rules apply to your business’s circumstances can be a complicated process with an ongoing need to stay up to date with changes in tax legislation, although taking professional advice can help to clarify your tax situation.
One important element in this process is an awareness of which capital allowance rates apply to you and your business, hence enabling you to calculate the correct level of available tax relief.
Tax legislation is constantly undergoing change, increasingly complex and often the reason that many businesses are unaware of opportunities to claim tax relief or do not use such relief efficiently.
An excellent example of this is the area of commercial property owners, where under a tenth claim the capital allowances available to them.
From our experience, this unawareness and inefficient use of capital allowances by businesses is not unusual.
Capital allowance claims
Capital allowance is a business-related relief available to companies, partnerships, foreign investors, the self-employed and in certain circumstances, private individuals, which may be claimed against certain assets purchased for business use. These assets include:
- business vehicles
which are collectively known as ‘plant and machinery’.
Generally, a capital asset will depreciate in value as it ages. This depreciation is then adjusted for by entering it as an expense in the profit and loss records. However, as part of the calculation of taxable business profits, this depreciation expense is added back in. This is where capital allowance can prove helpful.
Capital allowance may be claimed against the value of an asset at the time of purchase. A capital allowance claim can then be used to reduce a business’s taxable profit.
The percentage that may be claimed will depend on the category of asset and details of its use. For instance, under the Annual Investment Allowance (AIA), 100% may be claimed against purchased business assets up to the AIA limit. Where the total value of business assets purchased is more than the AIA limit, they may be claimed under the Writing Down Allowance (WDA) at 18%, or 6% applicable to the special rate pool for purchases made after April 2019 (8% for assets purchased before this date).
Where AIA is used and the limit not exceeded, the purchased asset is effectively written off in that tax year. Where WDA is used, the value of that asset may be written off over more than one tax year.
Where the cash basis is used to work out a business’s profits, the items that you can generally claim for under capital allowance, such as plant and machinery, will instead by registered as an expense, with the exception of the purchase of cars.
Capital allowance claims can only be made for assets that you own. Items that are leased or rented are not eligible and should instead be entered as expenses. In addition to assets in your ownership, there are a number of capital expenditure classes that may be eligible for capital allowance.
There is no complete listing of assets or expenditure that qualify for capital allowance.
HMRC provides the basic level of information on capital allowance and how this form of tax relief may apply to your business’s taxable expenditure, but it is down to you to interpret this information within the circumstances of your business. It is this interpretation, often without professional advice, which can lead to a business’s eligibility for tax relief not being fully recognised.
For instance, the category of fixtures is an allowable asset but is not fully explained on HMRC website which simply provides examples, such as bathroom suites.
Once a list of eligible assets has been drawn, the next step is to decide which of the following capital allowance schemes are right for your claim:
- Annual investment allowance (AIA)
- Writing down allowance (WDA)
- Small pools allowance
- First-year allowance (FYA)
- Balancing allowance
Each of these schemes has their own rules and rates, and it may be that more than one allowance applies in any tax year.
The first-year allowance, for example, will allow you to deduct the full cost of qualifying assets from your profits before tax.
Capital allowances rates
To comply with HMRC legislation, it is important that you realise the relevant rates and rules for any capital allowance scheme you make a claim through.
The capital allowance rates are:
- Annual investment allowance (AIA) – 100% up to the annual limit of £1 million (set up until December 2020)
- First-year allowance (FYA) – 100%
- Writing down allowance (WDA) – main pool 18%, special rate pool 6% after April 2019, single assets pool 18% or 6%
- Small pool write-off – 100% if the balance in main or special rate pool is £1,000 or less before working out the allowance
Use AIA or FYA to claim for an asset in the tax year of purchase. Both allowances lead to a 100% claim. The AIA annual limit was increased to £1 million in January 2019 for a period of two years, until December 2020.
Where the business asset is a gift, was owned by you before you used it in the business, or is a car, AIA is not applicable. Make a claim through WDA instead.
Although you can’t claim for cars on AIA, you can claim for lorries, vans, and trucks. You can also claim for motorcycles bought after 6 April 2009.
Where you claim for an asset after the year of purchase, use WDA.
Whichever capital allowance scheme you use, submit it as part of your HMRC tax return. If your claim is accepted, the amount will be deducted from your taxable business profit.
Be aware that should you sell an asset, you may have to pay tax at that point. Plan ahead, with the use of professional advice, to ensure that any sale is carried out within the related tax rules and time limits, hence limiting any possible tax liability.
Calculate the value of an asset
Generally, the value of an asset will be the price paid for it. Where the asset was in your ownership before it was used in the business or was a gift, it will not be possible to use the purchase price. Instead, the value of the asset is taken as the market value.
Capital allowance or business expense?
Where capital allowance doesn’t apply to a business expenditure, it may still be possible to make a claim for it under business expenses.
First, a business expense must be made exclusively for the business and not used for any non-business purposes.
Second, there is some variation on what can be claimed, depending on whether the claim is from a limited company or a sole trader, for instance. Typical business expenses include stationery, office rent, and insurance costs.
Capital allowance – key takeway
With the possibility of partial to full tax relief against purchased business assets, it makes sense for any company or eligible party to take full advantage of the various capital allowance schemes available.
Applying the complicated rules and calculations involved with making capital allowance claims, however, can mean that many companies remain unaware of their eligibility for capital allowance or do not claim the full amount available to them.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute tax, financial or legal advice, nor is it a complete or authoritative statement of the rules 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 tax, financial, legal or other advice should be sought.