What Are Capital Allowances? A Guide to Mastering Your Business Finances

Whether you’re a brand new start-up, a freelancer operating as a limited company, or the long-standing owner of a well-established business, it’s high time you got your head around capital allowances. You’ll no doubt have heard of these allowances, as well as the similar-sounding Capital Gains Tax; but when it comes down to it, what are capital allowances exactly?

For many business owners, the answer has often been: capital allowances are something best left to the accountant at the end of the tax year.

But  without a working knowledge of capital allowances yourself, you could in fact be missing out on a number of business benefits and cost savings—the likes of which could dramatically improve your bottom line.

In short, capital allowances are one of the most efficient ways for UK businesses to pay less tax. In the most recent tax year, companies in the UK saved £155.3 billion in tax—more than ever before—through their capital allowance claims.

So, now to the billion pound question, what are capital cost allowances and how do they work?

How do capital allowances work?

A capital allowance is a type of deductible business expenditure you can write off against your year-end taxable profit. Capital allowances pertain specifically to the sorts of business purchases you make to start up, run, and improve your business. Naturally, there are some caveats to be aware of, but as a general rule, capital allowances will cover most of the assets your business purchases exclusively for its business use.

HMRC introduced capital allowances in taxation as the most recent step in a long history of British business tax regulation. The idea was to encourage companies to regularly invest in new equipment and assets, thus stimulating the economy both by their investment and the improvement of their business.

The confusing part for most companies, though, tends to be defining an asset, and knowing whether a purchase they make during the tax year will be deductible at the end of it. The answer to this question is key to making capital cost allowances work for you and getting the most out of your turnover. Since assets can mean different things for different businesses, you’ll need to understand how capital allowances work for each type of asset class.

What assets can I claim capital allowances on?

Businesses are allowed to claim capital allowances on so-called ‘plant and machinery’, including business vehicles like lorries, vans and business cars. ‘Plant and machinery’ is the term HMRC uses for items that you keep and use for business purposes only.

It may be more helpful to have a look at some of the specific examples of allowable plant and machinery as provided on HMRC’s website.

• Assets that you keep and use in the running of your business. E.g., you can usually claim capital allowances on cars used for work purposes. As already mentioned, different businesses will consider different assets to be ‘plant and machinery’. The golden rule is: if you purchase the asset to be used in and by your business (and not for personal use by you or your employees/colleagues), then it is most likely allowable.
  • A café owner may include assets like coffee machines, ovens for baking, and tables and chairs in their ‘plant and machinery’. Likewise…
  • A sole trader personal trainer’s ‘plant and machinery’ might include branded sports equipment.
  • An accountancy firm could include computer hardware and stationery
  • A car manufacturer would include the machinery used in the production of their cars, and so on.
• The costs incurred from destroying or disposing of your plant and machinery.
• The costs of purchasing and installing integral features in business buildings, such as lifts, electrics and air conditioning.
• The costs of installing kitchens and bathrooms in a business building or, potentially, in a rental property you own or are building.
• Any other necessary building work completed in order to install new plant and machinery.

Top tip: For a capital allowance to be legally deducted from your annual profit before tax is applied, it must have been purchased by your business. You cannot claim capital allowances on assets purchased or plant-and-machinery costs incurred if they were paid for by someone else.

Exceptions

There are some things that you might think would be considered plant and machinery under capital allowances guidelines, which in fact are not allowable.

• You can’t claim capital allowances on leased assets, only purchased ones
• You can’t claim capital allowances on buildings, land or structures
• You can’t claim capital allowances on business acquisitions made for entertainment purposes (such as a karaoke machine or a yacht)

What are the benefits of claiming capital allowances?

There are a number of advantages and benefits to claiming tax exemption on business assets as capital allowances. Here’s a brief look at the top three:

1. Claiming business assets as capital allowances helps you to save on your yearly tax bill.
2. Deducting allowable assets from your tax bill can also free up cash, thus helping to improve your cash flow—particularly crucial for young and small businesses alike.
3. Lastly, using capital allowances to their full potential can give you greater control over the impact of asset acquisition, enabling you to write off the cost of an asset over a period of time (rather than all at once).

Exploring the different types of capital allowance

There are a few different types of capital allowances to consider: Annual Investment Allowance (AIA), First Year Allowance (also known as Enhanced Capital Allowance) and the historic ‘Super-Deduction’ Allowance.

Annual Investment Allowance (AIA)

AIA is typically the most significant type of capital allowance claim a business will be able to make. The annual investment allowance amount changes periodically but is currently set at £1 million per year. As your annual allowance resets every year, it can sometimes be wise to delay or bring forward asset purchases to make the most of your entitlement.

AIA works by deducting the total cost of most business asset purchases (with certain exemptions, such as business car purchases) from the yearly profits you pay tax on. It’s common for businesses to split large purchases over two or more years to take full advantage of their million-pound AIA allowance.

AIA typically covers 100% of the value of business asset purchases.

What is Enhanced Capital Allowance (AKA First Year Allowance)?

Enhanced Capital Allowance, or First Year Allowance (FYA), is another type of capital allowance available on eligible business purchases. Like AIA, FYA also provides 100% tax relief on asset purchases, though with the crucial caveat that these be made on new and unused, green, environmentally friendly equipment.

HMRC uses FYA to incentivise companies across the UK to transition toward a greener, more sustainable economy. Enhanced Capital Allowances can be applied to environmentally friendly plant and machinery such as:

• Electric cars with zero CO2 emissions
• Zero-emission goods vehicles
• Equipment for electric vehicle charging stations, gas refuelling stations, and refuelling equipment for gas, biogas, and hydrogen.

FYA can be claimed alongside AIA so long as:

1. The qualifying criteria are met, and
2. Neither scheme is used to claim for the same asset

What were super-deductions on capital allowances?

On April 1^st 2021, the UK government announced a new, temporary “super deduction” rate of 130% tax relief on qualifying plant and machinery. This scheme came to an end on 31^st March 2023, however, and so is no longer applicable to your annual capital gains allowances.

Getting the most out of your Capital Allowances in the era of Making Tax Digital

Capital allowances, just like Capital Gains Tax (CGT), can be challenging to wrap your head around, yet taking the time to familiarise yourself with the process could ultimately save your business a great deal of money on your tax bill—not to mention improve your cash flow and ease the financial burden of business asset acquisitions.

With the introduction of HMRC’s new Making Tax Digital (MTD) programme, moreover, businesses and their owners can keep tabs on their year-on-year capital allowances more readily.

Naturally, however, even with a clearer understanding of capital allowances, not every business owner has the time or resources to truly get the most out of their capital allowance. In such cases as these, it’s worth taking time to seek the advice of a tax professional.

FAQs

What capital allowances do cars get?

The government wants to incentivise renewable energy; FYA could previously be used to claim against low-emission vehicle purchases, though this has now been reviewed. Today, only zero-emission vehicles are deductible.

What happens if my capital allowances claim is wrong?

If you overclaim on your capital allowances, you may have to make a repayment. Of course, if you underclaim, you could also miss out on tax savings. If unsure, ask yourself:  do I need an accountant?

What if I cannot claim on an item?

Items outside of AIA and FYA capital allowances eligibility may be eligible for less lucrative allowances instead, such as ‘writing down allowances’, currently set at 18% or 6% depending.