Can You Claim Capital Allowances?
When running a limited company, you will invariably incur several expenses, from purchasing equipment to postage costs. A perk of being the director of your own limited company is that you may be eligible to claim all of those expenses. Capital allowances let you claim tax relief on assets you buy for your company, and usually their cost can be offset against your profits.
Our comprehensive guide on capital allowances can help you gauge whether or not you’re able to get this tax relief; however, this can be a complex issue. If you’re still unsure about this subject, we’ll be happy to help. We’ve been contractor accountants for a long time, so we can give you the best advice on capital allowances.
Before we get into the details of capital allowances, it is essential to understand the basics of business expenses, and how to handle them. For a start-up or growing business, there are two types of expenses that you can incur: either revenue (trading) expenses, or capital expenses.
Revenue expenses are short-term expenses generally categorised as expenditure for generating revenue, and expenditure for maintaining revenue-generating assets. Revenue expenditure is the operational cost of running a business, which is why it’s also called trade expenditure. Revenue expenses are in most cases fully tax-deductible during the same year they occur, since they facilitate trade in that year.
Capital expenses are expenses incurred in the acquisition of long-term fixed assets. Long-term assets have a useful lifespan extending for more than one year. Capital expenses include things like the premise, equipment and vehicles; these assets are known as plant and machinery. The purpose of capital expenditure is to expand the business’ capacity to generate revenue. These expenditures are often used to undertake new projects or ventures or to establish new start-ups.
Since capital assets provide revenue-generating value to the company for years, the company accounts for the cost through year-by-year depreciation throughout the valuable lifespan of the asset. Companies cannot deduct the full cost of any capital expenditure during the same year it occurred.
What is a Capital Allowance?
Capital allowance is a way of obtaining tax relief for some types of capital expenses. The allowance enables the business to write off the cost of a capital asset over a period against taxable profits. A certain percentage of the cost of expense is allowed during the accounting period in which the expense was incurred. The government allows this tax relief on capital expenditure as an incentive for investors to undertake large-scale projects. These investments increase the country’s production capacity as well as stock capital.
However, the area of capital allowance is rather complicated, as it governs all allowance claims. The act determines the value deductible and the types of expenses allowable. There isn’t a distinct list of approved capital expenses that qualify for capital allowance. Eligible expenses are identified through vigorous fact-checking, and compliance with the law. The company must also meet specific conditions for these expenses to qualify entitlement to allowance.
The process of establishing allowable capital expenses and determining relief value requires financial and accounting expertise. Huge investments go into starting and growing a business. It is therefore important to understand whether even a fraction of that value is allowable as tax relief.
What are Capital Items?
Not every business asset is eligible for capital allowance. Plant and machinery solely owned by the company and not leased or rented under certain conditions qualify for the allowance. Research and development costs, premise renovations, patents and assured tenancies are also allowable.
Leased assets, entertainment assets including recreational vehicles, buildings and land structures such as gates, monuments and bridges cannot be claimed under capital allowances.
Types of Capital Allowances
There are different types of capital allowances. Each type has its specific rules and procedures when making a claim. You need to understand each one of them to determine the most suitable approach to making a capital allowance claim. The main types are:
• Annual investment allowance
• First year allowance
• Writing down allowance
• Balancing allowance
From the four, however, the two most commonly used (and available) capital allowances are annual investment allowance (AIA), and writing down allowance.
Annual Investment Allowance
Annual investment allowance is a type of capital allowance that allows a business to write off entirely the cost of most plant and machinery items against the profits of the year in which the expense occurred. The maximum amount deductible in annual investment allowance is £200,000. AIA is available for most plant and machinery assets; also included are integral fixtures (such as heating and plumbing), alterations to install plant and machinery, and costs of demolition of plant and machinery.
One of the main exclusion of AIA is cars. The cost of items previously owned for other reasons before integration into business use are also excluded from AIA claim. Claims cannot be made for items given to you or the company.
AIA deductible amount changes over time and is influenced by economic factors and national revenue adjustments. For instance, between April 2008 and January 2016, the AIA amount fluctuated several times, varying considerably from low figures of £25,000 to highs of £500,000. If the AIA maximum claim amount changes within the period you are claiming, you need to adjust your claim amount in turn. Gorilla Accounting can advise you on the AIA for the relating period.
You also need to adjust your AIA if your accounting period is more or less than 12 months by factoring in your account period to 12 months. However, for accounting periods longer than 18 months, you will need to split the time into two periods: a twelve-month period and the remaining time factored into 12 months.
AIA is not valid for partnerships where one partner is part of another partnership or company. If you own more than one business, each should get its own AIA. To get a common AIA for multiple companies or trades, you either have to be the sole owner of all the businesses, have the companies in the same premise or have similar operations and trading activities. In such a case, you decide how to share the AIA between your enterprise.
Writing Down Allowance
Writing down allowance is a type of capital allowance that lets the business claim a deduction as a percentage of the value of an item every year. It is applicable in two conditions:
1. Claimed AIA items already exceed the AIA amount for that year.
2. The item does not qualify for AIA, despite being a capital asset – For instance, cars, business gifts, and property owned before their use in business.
Claiming Writing Down Allowance
Usually, the value of the item is the amount you paid for the item upon purchase. The market value determines the cost of items you owned before you started using them for business, and gifts.
The percentage you deduct is dependent on the item. While claiming writing down allowance, you need to group items into pools depending on the rate they are eligible for. There are mainly three types of pools.
The Main Pool: This pool has an 18% rate, which applies to most assets in the plant and machinery category.
Special Rate Pool: This is a lower 8% rate, which includes items with a long life (at least 25 years), cars with CO2 emission in excess of 130g/Km, and a buildings’ integral fixtures.
Single Asset Pool: With varying rates of 18% and 8%, depending on the item, it may be necessary to create this pool for short-life assets, as well as those used outside of the business. Once you know the rate of the item, determine how much you can claim for it and deduct the amount from your profits before tax from the accounting period. The amount remaining in each pool becomes the initial balance of the proceeding accounting period.
First Year Allowance
First year allowance permits companies to deduct between 6% and 100% of the cost of eligible capital investment during the year the item was first purchased. First year allowance came as a government tax incentive for British companies to invest more in capital items to grow the economy, as well as to encourage the purchase of eco-friendly and efficient equipment.
What Qualifies for First Year Allowance?
Capital items that qualify for first year allowance include:
• Cars meeting standards in low CO2 emissions.
• Energy-saving equipment.
• Water-saving equipment (water-efficient systems).
• Plant and machinery for refuelling stations.
• Bio-gas and hydrogen refilling equipment.
• Zero emissions transit vehicles.
You cannot make claims on items leased out to other people or used within a premise that you let out. If your business does not claim the first-year allowance during the single tax year, you can still claim a partial reduction the following year using the writing down allowance.
As an investor, you need to be aware of what happens if you were to dispose of an item on which you have already claimed a capital allowance.
Balancing charge is a bit like the opposite of capital allowance. After disposing of an asset, there is an amount deducted from or added to the pre-tax profit to reflect the depreciation of a fixed asset falling or exceeding the capital allowance deducted on it. A balancing charge can increase the amount of taxable profit. It is there to make sure that you don’t claim too much tax relief on account of capital allowance.
When you dispose of an asset that you have already claimed capital allowance on, you must include a calculated value to the taxable profit for the year sold. ‘Disposing of’ is a somewhat flexible term and may mean selling, swapping, giving away or decommissioning.
Calculating Balancing Charge
If you claimed 100% of the value of the item under first year allowances or annual investment allowance, you have to add the full sale proceeds to your pre-tax profits. If you have a balance in the pool that your item qualifies for, deduct a total value from that pool and add the difference to your pre-tax profit. If there remains a balance in the same pool, you can claim a writing down allowance on it. Even if you sold the item for more than it cost, you could only deduct the initial cost.
If you used writing down allowance on the item you have disposed of, deduct the value from the original pool; the amount left should give you a calculation of your next writing down allowance. If the value deducted exceeds the pool balance, then add the difference as a balancing charge to your profits. You can claim any amount left as capital allowance (balancing allowance) in a single assets pool.
You can only claim balancing allowance in the main and special pools when the business closes. When you close your business, you should enter a balancing allowance or a balancing charge in the tax return instead of claiming capital allowance.
Why You Should Claim Capital Allowance?
Capital allowance is a legal right for companies and investors. It is a tax relief from the government to reward hard-working companies who are contributing to the nation’s industrial and economic growth. After all, growing or starting a business requires a substantial injection of capital. Even though businesses are run for profit, the government appreciates the investment, because it realises the economic impact that businesses have on the state of a country and its citizens. That is why it provides this incentive to invest more.
The sum of capital assets even in a small business can amount to thousands of pounds. Large businesses invest millions in equipment and trade infrastructure. Claiming capital allowance on these assets that you need to have anyway, saves the taxpayers millions of pounds every year. When it comes down to it, every penny counts, regardless of the scale of your business.
Claiming capital allowance, however, is not necessarily an easy task. Especially for new businesses unfamiliar with tax procedures, and businesses with varying asset dynamics. You have to monitor all of your assets to get an accurate valuation and there is plenty of paperwork and can be value assessments. Moreover, just to make things ever so slightly harder, the laws and regulations governing capital allowance keep changing.
This is where Gorilla Accounting come in handy. It’s difficult to keep a handle on your business, while constantly worrying over taxation and asset management in a changing environment, so let us do it for you. Use our contractor tax calculator to calculate your take-home pay, or get in touch with our experienced team for more in-depth information about capital allowance and other tax or accounting-related queries.