You are busily filling in your business tax return doing fine with the income and the expenses but suddenly you are brought to a grinding halt in confusion. Capital allowances, what are they all about? Will I miss out if I don’t have them? How do I work them out? Quick find an accountant!
Capital allowances are really not so scary and you could potentially work them out yourself, or if you choose to have your accounts done, at least know what your accountant is talking about. Capital allowances are actually pretty good for your business and should be considered your friend. Here are the basics:
“Hey big spender” or capital v. revenue
The first thing to think about is that there are two different kinds of spending in your business.
Revenue spending is what you normally think of as expenses; it is the spending required to run the business in the current year. Examples are goods for sale, materials, admin expenses, heat and light, rent and repairs. The money is spent (or at least owed) in the year and the item or service purchased is generally used up in the year.
Capital spending is when you buy an asset that will be used by the business for a number of years. For a small business an asset is generally an item of equipment, otherwise known as plant and machinery, but can also be land and buildings. We use a rough and ready guideline for small businesses, defining an asset as an items of equipment costing over £100 with a working lifespan of more than 3 years. However there is no firm categorisation, it will depend on the size of your business – for a large business even £1,000 spend may not be considered an asset. The main things to remember are bigger spend and longer lifespan. Examples include vehicles, computers and large tools.
Spreading the cost – depreciation
Revenue items affect your profit in the year that you buy them. The more money you spend, the less profit there will be. Capital items are treated differently.
If an item is going to last five years and give benefit to the business for five years, then it makes sense to spread cost over five years in the accounts. Spreading the cost over a number of years is called depreciation. When you get your accounts balance sheet there will be a section for assets, such as plant and machinery. What this section is showing is how the cost of your asset is being spread out via depreciation and how much is being used up this year. This is all done in the accounts and has no relation to the actual flow of money that took place.
All assets start out living in the balance sheet where they don’t affect the profit in your accounts. Each year a chunk of the asset cost moves from the balance sheet to become an expense called depreciation, reducing your profit. After a certain number of years (generally four of five) the asset cost will be totally or almost totally used up, depending on how your accountant is spreading out the cost.
Accountant get to choose how they depreciate your assets to spread the cost. There different methods such as straight line and reducing balance and different rates depending on the lifespan of the asset. The accountant will pick the most appropriate method depending on the asset and your business. We generally use a simple straight line method that divides the asset cost by the number of years of it’s life, so a computer costing £400 and lasting four years will have £100 depreciation put as an expense each year for four years.
HMRC rules – capital allowances
However, what this means is that everyone’s accounts can vary as to how assets are treated for depreciation. HMRC likes consistency. They prefer everyone to do the same so they have their own method of depreciation called Capital Allowances.
When your accounts are submitted to HMRC to work out the tax, any depreciation expense that your accountant has put in has to be taken out and not included. But you don’t miss out because you get to use the HMRC capital allowances instead.
Capital allowances can be great for a business because they give more flexibility. Whereas an depreciation must be put in whether you want it or not, you can actually choose whether to use some of your capital allowances or whether to save them for the future. This means if you have made a loss with your business one year, you can save up your capital allowances until you are making a profit. You can then use them to reduce the amount of profit and pay less tax.
How much can you claim?
There are different rates for different types of expenditure which sound complex but also helps with flexibility. I’m just going to cover the most common ones but if you need more information then HMRC website has lots of detail or your accountant will help you.
Annual investment allowance (AIA) – 100%
If you want, you can claim 100% of the cost of plant and machinery in the year that you buy it as a first year allowance. This applies to equipment, machinery and to work vans, but not to cars. The maximum amount that you can claim in AIA varies from year to year but at the moment it is £200,000. Very important to note, you can only use your full AIA in the year that you buy the asset.
If you choose not to use your AIA in the year that you buy the asset, then you won’t be able to claim 100% next year, just the standard Writing Down Allowance rate. It is generally worth claiming your AIA every time, even if you are making a loss because otherwise you will lose it. If you are making a loss, then the loss can be carried forward and used against future profits, so you will still get the use of your AIA. However, it is worth speaking to an accountant about your individual circumstances if they are not totally straightforward.
If you are bringing assets into the business that you previously owned for another reason, then you can’t claim the AIA. For example, if you want to bring your personal laptop into the business as an asset, you have to use the current market value (not the purchase value) and you can only claim the WDA (see below) and not the AIA.
First year allowance (FYA) – 100%
Writing down allowances (WDA) – 8% or 18%
This is the standard rate for most cars and for anything you didn’t claim AIA on. You can have a percentage of the remaining value of the asset each year, if you choose, until the asset is used up. Remember for capital allowances the % is based on the remaining value of the asset, not the initial cost.
HMRC likes to think of assets as living in pools (which does make me think of frogs etc). Different types of asset live in different pools. You can have a very varied asset ecosystem depending on what assets you have. The main pools to think about are:
Special rate pool: Cars (plus some other items) = 8% per year
Main rate pool: Everything else including vans = 18% per year.
Which pool a car ends up in depends on the CO2 emissions. Lower emissions = a better pool rate so it is worth considering this when you choose a car.
Small Pools Allowance – 100%
If one of your pools gets down to less than £1,000 in value after you have used your AIA for the year, you can claim all of the remaining amount at once as a small pools allowance.
You can’t have personal use
If you have an asset e.g. a computer or a car that is used partially for business and partially for personal, then you can only have capital allowances on the business part. For example, if you buy a computer for £800 but will use it 50% for personal use, then instead of claiming the full £800 for your AIA (annual investment allowance), you should only claim £400.
Also HMRC likes these half-and-half assets to live a lonely life in their own individual pools and not in the pools with your 100% business assets.
Disposals – this is the complicated bit
Mostly capital allowances are quite straightforward, you generally claim your AIA for anything you buy in the year (apart from cars) and any cars get the WDA. If you don’t want to claim some or all of the capital allowances in the year, you don’t have to.
The complication comes when you sell an asset, particularly one where you have claimed the 100% AIA. This bit probably does require some accountancy advice as you might end up having to “give back” some capital allowances. If you want to know more then take a look at HRMC – selling or disposing of pooled assets.
What to remember
Large, high value items within your business, otherwise known as assets, need to be treated differently to day-to-day revenue expenses
Depreciation is about spreading the cost of an asset over a number of years in your accounts. But depreciation is not a real flow of money, just an accounting concept
HMRC has its own system of depreciation called capital allowances so your tax return will be slightly different to your accounts
Assets live in different capital allowance pools with different capital allowance rates
Most items can have AIA of 100% in the first year and this is generally a good idea to use this
Cars don’t get AIA and most of them get a lower capital allowance rate
You can’t have capital allowances on the private use element of an asset
Disposals can be complicated
Image – “Going for a swim” by Darrenkw