What are Capital Allowances and how do they work?
June 26, 2020

Michael Chadwick - what are capital allowancesHow to reduce your tax bill by making the most of Capital Allowances

In this article, founding Director, Michael Chadwick, discusses fixed or tangible assets. He explains how the timing of their purchase could save you a significant amount of tax and what you can claim back as a Capital Allowance.

A Capital Allowance is an expenditure your business may claim against its taxable profit. Capital Allowances may be ​claimed on most assets purchased for use within your business.

The definition of an asset can alter from business to business. An asset is anything of financial value owned by a person or business. This can then be classified further into categories of land and buildings, fixtures and fittings, motor vehicles, computer equipment, plant and machinery, or stock and cash held at a company’s year-end. Each asset has a different function in your business and the tax rules relating to each can be very different.

Depreciation and Capital Allowances

As an example, imagine Smith Ltd purchases a computer during the year. This computer is now an asset of Smith Ltd and so it will be depreciated by their accountant when preparing the year-end accounts. This depreciation charge is an expense to the company, but it does not reduce the profits for corporation tax.

The Government recognises that depreciation is a vague concept and consequently it has special rules which must be used in order to collect your tax relief. These rules are called ‘Capital Allowances’.

Capital Allowances explained

HMRC are often used to help implement Government economic policies. As an example, they may want to encourage companies and individuals to invest in new machinery and plant. Thus they regularly modify Capital Allowances. These deductions from your annual profits can massively impact the amount of tax that you pay. In extreme cases, this can even cancel a Corporation Tax Liability even when a profit has been earned.

Annual Investment Allowance

The largest Capital Allowance that businesses will utilise is known as the Annual Investment Allowance (AIA). This allows businesses to deduct up to £1,000,000 of expenditure on assets used in their trade. This rate came in to effect from January 2019. Previously this figure was £200,000. Every company gets an AIA each year. Thus, we can see there may be a tax advantage in timing the purchase of new machinery to exploit this new rule.

For example, it might be better to acquire two expensive machines either side of the financial year-end, rather than buying them together. If you were to buy the items separately, you would qualify for two AIA claims, rather than exceeding the £1million limit. If you exceed this limit you fall into the less user-friendly ‘Capital Allowance special rate pool where you can only claim tax relief of 6% or 18%. This is significantly less than AIA’s 100% tax relief, so demonstrates the importance of strategically timing your asset purchases.

First Year Allowance

As well as the Annual Investment allowance, there is also the First Year Allowance (FYA). This gives relief of 100% of the price of specialist ‘green’ technology that is deemed to be energy efficient. This is a way the Government encourages us to buy green technology by allowing a deduction of the full cost from your profits before tax. This green technology includes:

  • cars with low CO2 emissions
  • energy-saving equipment
  • water-saving equipment
  • plant and machinery for gas refueling stations
  • gas, biogas and hydrogen refueling equipment
  • new zero-emission goods vehicles.

It is partly the first year allowance which has lead to the growth of hybrid and electric cars, so is often called ‘corporation tax relief on electric cars’.

It is important to note that this scheme is separate from the AIA. Your company could potentially claim both £1million pounds worth of AIA, plus 100% of your green technology if you invested in the right qualifying assets.

Writing Down Allowance

Regular petrol or diesel car do not qualify for either of these allowances. The Government wants to encourage green technology and as a result, these vehicles do not qualify for either AIA or FYA.

Instead, along with other assets that have missed out on AIA or FYA, cars go into a collective pool where they are written off by HMRC at either 6% or 18% of their cost, depending on their CO2 emissions.

Tax relief on fixed assets

Capital Allowances are calculated when your year-end accounts are prepared. As this will not be until beyond your year-end, this means you may be waiting some time until your tax relief is applied and you actually feel the benefit of the purchase.

However, once the asset is under the control of your business you can potentially claim back any VAT you have incurred on the purchase. Often this can be a significant amount, so immediately lowering your VAT bill for the quarter.

This also applies if you are purchasing the asset through a hire purchase contract. In this scenario you may be paying direct debit payments for one or two months in the quarter, but able to claim back a large chunk of the total asset price in your next VAT return – therefore having a very positive effect on your cash flow.

Our corporate tax services

As a firm of Chartered Accountants, we are able to provide all of the services discussed in this article. Be that as a year-end accountancy service or throughout the year to discuss corporate tax planning ideas.

Find out more about how our specialist corporate tax accountants can benefit your business.

We offer a free, no-obligation, initial meeting where we provide information on:

  • The accounts preparation process
  • An assessment of where your business currently stands
  • A discussion about any potential tax-saving opportunities
  • An explanation of our fees
  • Our organisation, history and the experience we can bring to your business.

New clients are paired with a qualified partner and manager who provides one-to-one support throughout the year. We will meet with you regularly to discuss your financial performance, changes in your industry sector and any plans you have for your business. We take great pride in delivering a high quality service and providing meaningful recommendations to help drive your business forward.

To find out more or to get a quote, email or call us on 0161 370 9600.

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