Capital Allowance: What is it and who can claim it

What is capital allowance?

Capital allowance is the amount of money spent by a business on capital assets which can be claimed from the amount of taxes owed by the business.

The cost of acquiring a capital asset for a business is higher than the cost of day-to-day operations. Depreciation occurs when a piece of the asset’s worth is shown as a day-to-day operating cost, diminishing the business’ profit.

Capital allowances compensate for the fact that depreciation costs are not tax-deductible by allowing the business to deduct the capital allowance from its profit before calculating the tax. 

Capital allowances are not automatically given; instead, they must be claimed in a tax return. However, they can be claimed at any time as long as the asset is still owned and used in the trade.

What can it be claimed on?

Capital allowances can be claimed on plant and machinery, on renovating business premises in disadvantaged areas of the UK, extracting minerals, R&D, ‘know-how’ (intellectual property about industrial techniques), patent rights, and dredging allowances, structures and buildings. In most cases, the full cost of these items can be subtracted from the profits before taxes using the annual investment allowance (AIA).

Plant and machinery allowance cannot be claimed on leased items, they must be owned. Items used purely for business entertainment are also not eligible for capital allowance. Along with land, structures also include bridges, roads, docks and buildings.

Cars do not qualify for an annual investment allowance.

Benefits

Capital allowances provide several benefits:

– Obtaining an immediate tax or cash benefit;

– Minimizing or removing a tax liability;

– There are no limitations on high earners claiming wear and tear allowances or most industrial building allowances;

– Elevating cash flow and keeping that money in the business;

– Possible cash refund / tax repayment;

– There is no specific relief.

First-year allowances

If an asset which is eligible for first-year allowances is acquired, the full amount from the pre-tax profits can be deducted. First-year allowances can be claimed in addition to annual investment allowances; they do not count against the AIA limit.

If all of the first-year allowances are not claimed, a portion of the cost can be claimed in the following accounting period using writing down allowances.

Rates

Capital allowance rates vary depending on the type of capital expenditure and the date it was incurred. 

The purchase date is when the payment is due, if the payment is due less than four months from the date the contract is signed, or later if the payment is due more than four months after.

The three types of rates are as follows:

• Main rate: 18%

Unless they fall under one of the other two types of rates, the value of all plants and machinery purchased should be included in the main rate.

• Special rate: 6%

This rate is associated with items including integral components of a building or long-lasting items, such as thermal insulation of buildings.

• Single asset rate: 6% or 18% depending on the item.

If a single asset has a short life or is used outside of the business, it may be needed to use one or more different rates. It is entirely up to the user discretion whether an item is treated as a short-term asset or not.

How to claim?

Once the capital allowances have been determined, they must be claimed on:

· Self-Assessment tax return, in case of a sole trader;

· Partnership tax return, in case of a partner;

· Company Tax Return, in case of a limited company – a separate capital allowances calculation must be included.

To claim the total amount, it must be done during the accounting period in which the item was purchased. Otherwise, a portion of it can be claimed by writing down allowances. This can be done at any time, as long as there is still ownership of the item. 

Camilla Formicola

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