What are Capital Allowances?
Capital Allowances are how businesses claim tax relief on capital expenditure. This raises another question: what is capital expenditure?
Business expenditure can be split into two categories: revenue expenditure and capital expenditure.
Revenue expenses refer to the day-to-day running costs of a business, whereas capital expenses relate to assets that will be used by the business in its trade. This is a broad description as no legal definition exists of the two terms. For those in the building trade, the purchase of vans and expensive tools are frequent examples of capital expenditure. Cheap tools like saws, spanners and replacement parts like blades are a category of revenue expenditure known as “repairs and renewals”.
Capital allowances are calculated using various methods, depending on the asset purchased and the amount of expenditure. The following is a general guide to typical purchases of assets – there are of course always exceptions.
Annual Investment Allowance (“AIA”)
The Annual Investment Allowance allows you to claim the whole cost of up to £500,000 spent on assets classified as “plant and machinery” each year. The amount can vary between tax years so to see the current rate, check the HMRC website.
“Plant and machinery” in this context covers a wide range of expenses which for the typical sub-contractor would include tools and equipment, vans (but not cars) and computers.
When you sell an asset for which AIA has been claimed, let your accountant know as this will need to be shown on your tax return.
Writing Down Allowances
If you spend more than the AIA limit, you can normally claim writing down allowances which is 18% on a “reducing basis”. This means you claim 18% of the cost in the first year, 18% on the remaining cost in the following year, then 18% on the remaining cost in the year after that and so on.
Here is an example:
- Cost of assets not qualifying for AIA: £50,000
- 18% capital allowances (“CAs”) claimed in 2013/14 £9,000
- Remaining cost (known as Tax Written Down Value or “TWDV”) £41,000
- 18% CAs claimed in 2014/15 (£41,000 x 18%) £7,380
- Tax written down value £33,620
- 18% CAs claimed in 2015/16 (£33,620 x 18%) £6,052
- Tax written down value £27,568
If you buy further assets that are above the limit for annual investment allowances, you add them to the Tax Written Down Value and calculate capital allowances on the combined new total.
When you sell assets, the proceeds are deducted from the Tax Written Down Value and you calculate capital allowances as per normal on the new total.
How are capital allowances calculated on cars?
There is a unique system for claiming capital allowances on cars.
If you are using the mileage basis to claim car expenses (i.e. 45p per business mile), you cannot claim capital allowances as the 45p is deemed to include the cost of the car.
The amount of capital allowances you can claim is determined by the CO2 emissions. From April 2013, the allowances are as follows:
- For new cars with CO2 emissions of 95g/km or less, 100% of the cost can be claimed.
- For CO2 emissions of 130g/km or less, you claim 18% on a reducing basis. (The reducing basis method is illustrated above)
- For CO2 emissions higher than 130g/km, you claim 8% on a reducing basis.
Details of the latest allowances can be found on the HMRC website.
How do you account for personal usage on capital allowances?
If you use an asset for both business and personal use, you should reduce the capital allowance claimed by the proportion of private use. So, for example, if you buy a van for £10,000 you would be able to claim £10,000 Annual Investment Allowance (“AIA”). But let’s say you use the van 20% of the time for private use. 20% of £10,000 is £2,000 so you would reduce the AIA by £2,000 and claim £8,000.
Bear in mind that as with many areas of tax, capital allowances are a complex area and so professional advice should be sought to determine the correct tax treatment of assets purchased applicable to your business. Additionally, rates and regulations are subject to frequent change.