What are Capital Allowances in the UK?
Thinking of investing in a new laptop? Of buying a business vehicle? Or of getting some other piece of equipment you need for your business or to help it operate more efficiently?
These purchases are usually tax-deductible. But HMRC doesn’t treat them the same way they treat day-to-day expenses such as business mileage and office utilities. You can’t just subtract the cost from your income. To get your tax deduction, you’ll have to claim capital allowances.
Here’s a rundown of what capital allowances are and how they work in the UK.
What are capital allowances?
Capital allowances are a way of reducing your tax bill when you spend money on something that’ll benefit your business in the long term. This is called capital expenditure.
You make capital expenditure when you:
- Buy an asset you’ll use in your business. This is called a capital asset
- Spend money on upgrades
- Spend money on maintaining a capital asset.
What counts as a capital asset?
Unfortunately, there are no hard and fast rules. According to HMRC’s latest toolkit, it depends on your business and circumstances. What might count as a capital asset for one business won’t necessarily count for another.
That said, a capital asset will usually be something that:
You need for your business
So, if you run a tailoring shop, your sewing machine would be a capital asset. By contrast, if you’re a baker, a sewing machine wouldn’t count as a capital asset, even if you use it to mend your aprons
Is relatively expensive
HMRC don’t have a specific threshold above which an expense becomes a capital asset. It depends on the size of your business. A piece of equipment worth £150 could be a capital asset if you’re a one-person operation working from your basement. But the same purchase could count as a day-to-day expense for a multi-million pound company.
Will benefit your business in the long-term
Again, there’s no exact definition of ‘long-term’. That said, as a rule, you should be able to use a capital asset for more than a year.
Can I claim capital allowances on all capital assets?
No. Not every capital asset qualifies for capital allowances. Luckily, HMRC has rules on which assets you can and can not claim capital allowances on.
Claiming capital allowances: Plant and machinery
Plant and machinery is the most common type of asset you can claim capital allowances on. It’s equipment, machinery or vehicles that you use in your business. So, if you run a delivery company, plant and machinery would include the forklifts you use to stack goods in your warehouse and the vans your employees use to deliver goods to your customers’ premises.
Plant and machinery also include:
- The cost of demolishing equipment, machinery or vehicles
- Features that are integral to a building or structure. These are:
- lifts, escalators and moving walkways
- heating and air conditioning systems
- hot and cold water systems
- electrical and lighting systems
- external solar shading
- Fixtures, such as kitchens, bathrooms, CCTV and fire alarm.
When can I claim capital allowances on plant and machinery?
You can claim capital allowances only on things you own. So, if you rent a van, you’d have to deduct the rental cost from your day-to-day expenses (do note, however, that HMRC allows you to claim capital allowances on some leasing arrangements, such as hire-purchase).
Also, you can’t claim capital allowances on:
- Buildings, including doors, gates, shutters, mains water and mains gas
- Land and structures such as bridges, roads and docks
- Items you use only for business entertainment (this means you can’t claim capital allowances on that air-hockey table, sorry).
How do I claim capital allowances?
You can claim capital allowances in one of two ways: through the annual investment allowance or through writing down allowances.
Let’s have a look at each in turn.
Claiming capital allowances: The annual investment allowance
The annual investment allowance allows you to deduct the full value of plant and machinery, up to £200,000 per year. The catch is that you can claim it only in the year you bought the equipment.
Annual investment allowance: Example
Let’s say you’re a baker. In 2018/19, your total taxable profit (that is, your profit after allowable expenses) is £50,000.
During the year, you invested in three ovens, each worth £1,500. You also bought a van for deliveries. This cost £10,000.
In total, you spent £14,500. This is much lower than the £200,000 annual investment allowance limit. So, you can deduct it from your total taxable profit for the year.
As a result, you’d pay tax on £35,000 instead of £50,000.
However, if you don’t claim the £14,500 in 2018/19, you lose it.
Claiming capital allowances: Writing down allowances
You can claim a writing down allowance if:
- You’ve exceeded your annual investment allowance. In other words, you spent more than £200,000 on plant and machinery in a given tax year
- The item you want to claim capital allowances for isn’t covered under the annual investment allowance. The annual investment allowance doesn’t cover:
- Car writing down allowances have slightly different rules and are calculated differently to other plant and machinery
- Items you owned before you started your business and used for other reasons. Let’s say you used your laptop only to play Fortnite and browse Twitter. If you decide to start a graphic design business and use your laptop for work, you won’t be able to claim an annual investment allowance for it. You’ll have to claim writing down allowances instead
- Gifts, for example, if your parents buy you a new laptop for your marketing business.
You can claim only a percentage of the item’s value as a writing down allowance each year. That said, you can keep claiming writing down allowances until the item’s value reaches zero. The amount your item is worth after you claim a writing down allowance is called a closing balance.
How do I Claim a Writing Down Allowance?
To claim a writing down allowance, you’ll have to:
- Work out the item’s value. This is what you paid for it. If it’s a gift or something you owned before you started your business, you’ll need to find out its market value
- Put each item into a ‘pool’. HMRC has three pools:
- Main rate pool. This is the default pool. Unless HMRC rules say that an item should go into another pool, you should put it here
- Special rate pool. A building’s integral features, items with a long life, building insulation and cars with more than 130g/km of CO2 emissions go here
- Single asset pool. Items with a short lifespan and items you also use outside your business (excluding cars and special rate pool items) go here. An example would be the crockery in a coffee shop
- Calculate the percentage you can claim as a writing down allowance. You can claim 18 percent per year on main rate pool items, 8 percent per year on special rate pool items and 18 or 8 percent per year on single asset pools, depending on the item
- If you’re a sole trader or in a partnership, deduct any personal use from the result.
Calculating writing down allowances: Example
Let’s say you spent £230,000 on capital expenditure in 2018/19. All of these expenses qualify for the annual investment allowance. However, you’ve exceeded the £200,000 limit, so you have to claim the extra £30,000 as writing down allowances.
All the £30,000 falls in the main rate pool. This means you can claim a writing-down allowance of 18 percent. None of the items is a car, and there is no personal use.
- In 2018/19, you can claim 18 percent of £30,000, that is £5,400. This would leave you with a closing balance of £24,600
- In 2019/20, you can claim 18 percent of £24,600, that is £4,428. This would leave you with a closing balance of £20,172
- In 2020/21, you can claim 18 percent of £20,172, that is £3,630.96. This would leave you with a closing balance of £16,541.04
- You can keep claiming a writing down allowance each year until you either sell the item or your closing balance hits zero.
Can I claim capital allowances on other types of expenditure?
Yes. Plant and machinery aside, HMRC also allow you to claim capital allowances on:
- Patents. A patent recognises you as an inventor and gives you the sole and exclusive right to use your invention as you see fit
- Research and development
- Intellectual property, or ‘know-how’ about industrial techniques
- Dredging, that is deepening or widening a waterway to make it easier for ships to sail through
- Extracting minerals
- Renovating business premises in disadvantaged parts of the UK.
What If I sell a capital asset?
Two things might happen if you sell a capital asset. Firstly, you may have to pay capital gains tax. And, secondly, you may have to add a balancing charge to your profits in the year you sell.
Let’s have a look at each in turn.
When do I pay capital gains tax?
You have to pay capital gains tax if:
- You sell a capital asset for more money than you pay for it. This includes your home, if you use part of it exclusively for business purposes
- Your profit exceeds the annual capital gains allowance, which is known as the Annual Exempt Amount (AEA). The capital gains tax allowance for 2018/19 is £11,700 (£5,850 for trusts)
- You’re a sole trader or partner. If you do business as a limited liability company, you’d pay corporation tax, not capital gains tax.
The current capital gains tax rates are:
- 10 percent if you’re a basic rate taxpayer
- 20 percent if you’re a higher rate taxpayer
- capital gains tax on residential property is 18 percent if you’re a basic rate taxpayer
- capital gains tax on residential property is 28 percent if you’re a higher rate taxpayer.
Capital gains tax: Example
Let’s say you’re a sole trader. A few years ago, you bought equipment worth £8,000 for your business.
In 2018/19 your total taxable profit was £30,000, which means you’re a basic rate taxpayer. You also sold your equipment for £14,000.
£14,000 is £2,300 over the £11,700 annual exempt amount. So, you’ll need to pay capital gains on this amount. Since you’re a basic rate taxpayer, you’d pay capital gains at 10 percent, that is £230.
When do I have to pay a balancing charge?
Unfortunately, capital gains tax isn’t the only money you might have to fork out if you sell a capital asset. You may have to pay a balancing charge if:
- You claimed the annual investment allowance or writing down allowances on the asset you’re selling
- You sold the asset for more than the annual investment allowance or writing down allowances you claimed
- You have to pay the balancing charge even if you didn’t make a profit
- You have to pay the balancing charge even if no capital gains tax is due.
Paying a balancing charge: Example
Let’s say you bought equipment worth £8,000 for your business.
In 2018/19, your total taxable profit is £30,000. You also sold your equipment for £6,000.
Since you sold the equipment for less than you bought it for, you don’t have to pay capital gains tax.
That said, you claimed £7,000 in writing down allowances over the years. So, you have to add a £1,000 balancing charge to your profits.
As a result, your total taxable profit for 2018/19 would go up from £30,000 to £31,000.