Capital Allowances: A Guide for the Self Employed

Capital allowances are a form of tax relief provided by the government to businesses and self employed individuals.

They enable you to deduct a portion of the cost of certain assets, such as machinery, equipment, and vehicles, from your taxable profits.

The tax relief achieved by claiming capital allowances helps offset the initial investment in these assets, making it more financially viable to acquire the tools and resources necessary to grow your business.

A key part to understanding capital allowances lies in recognising the distinction between revenue (trading) expenses and capital expenditure.

While revenue expenses like day-to-day operational costs are fully deductible in the tax year they are incurred, capital expenditure is treated differently.

This is where capital allowances come into play, providing a means to claim tax relief on the acquisition of assets (capital expenditure) over time.

There are various types of capital allowances available with different eligibility criteria. To make the most of the capital allowance relief available to your business you need to use the right approach and ensure you are HMRC compliant at the same time.

Who is eligible to claim capital allowances?

The regulations differ based on the specific capital allowance type. Generally capital allowances can be claimed by businesses including:

• Self employed sole traders.
• Partnerships.
• Limited companies.
• Commercial property investors.
• Employees can be entitled to claim capital allowances on tax paid through PAYE.

What expenditure qualifies for capital allowances?

Capital allowances can only be claimed on specific types of assets which have to be used to run your business and typically have to be owned to be eligible.

The most common type of assets that that qualify for capital allowances are known as plant and machinery.

Examples of plant and machinery that can qualify for capital allowances purposes include:

• Machinery.
• Tools.
• Computers.
• Cars.
• Vans.
• Business property integral features for example an electrical system or a lift.
• Business property fixtures for example a heating or CCTV system.

If an asset is used for both business and personal purposes, the capital allowances must be restricted to the proportion of business use.

Accurately determining and documenting the split between business and private use is crucial to ensure you claim the correct amount of allowances.

What is not considered as plant and machinery for capital allowances:

You are not eligible to claim plant and machinery allowances on all items.

• Gas or mains water systems.
• Leased items unless you can prove that you have a hire purchase contract or a long funding lease in place.

The legislation surrounding what qualifies for plant and machinery capital allowances can become confusing.

You can use the capital allowances act 2001 (CAA 2001) to find out more about what is allowable for your business.

What types of capital allowances are available?

When it comes to capital allowances there are several distinct categories that self employed individuals should be aware of.

The main types of capital allowances available to self employed individuals include:

• Annual investment allowance (AIA): Provides 100% tax relief on eligible assets in the year of purchase, up to the maximum annual limit.
• Writing down allowances (WDA): Provide tax relief on the remaining value of assets that don’t qualify for the AIA, with a ‘normal’ rate of 18% in the general pool and a 6% rate in the special rate pool.
• Capital allowances for cars: Offer varying levels of allowances based on the car’s CO2 emissions, with 100% first year allowances for zero emission vehicles and lower rates for higher-emission cars.

Choosing the right capital allowance scheme for your business is essential to avoid missing out on valuable tax relief and while also ensuring compliance with HMRC regulations.

Annual investment allowance (AIA)

The annual investment allowance is a particularly valuable capital allowance because it provides 100% tax relief on eligible assets in the year of purchase.

This means that if you buy a qualifying asset you can deduct the full cost from your taxable profits in the same year.

The AIA has a maximum annual limit, which has been set at £1,000,000 since 1 January 2019.

You can only make a claim under the AIA during the accounting period in which you purchased the item.

The relevant date of purchase depends on the following:

• If payment is due within a timeframe of less than 4 months, HMRC will consider the date of purchase to be when you signed the contract.
• If payment is due more than 4 months later the date of purchase is considered to be when payment is due.

You have the choice not to declare the entire expense in full (which can be helpful in a year of low profits) and instead:

• Allocate a portion of the cost as AIA and another portion as writing down allowances.

OR

• Utilise writing down allowances instead.

It’s important to note that certain assets, such as cars and integral features within a building, are excluded from the AIA and must be claimed through other capital allowance schemes.

Writing down allowances (WDA)

For assets that don’t qualify for the AIA or if you have exhausted your AIA limit you can claim writing down allowances (WDA).

Writing down allowances are calculated based on the remaining value of the asset, known as the ‘written down value’, which is carried forward from one tax year to the next.

The ‘normal’ WDA rate is 18% of the written down value in the general pool. There is also a lower rate of 6% for the special rate pool, which typically includes items like long life assets, integral features, and cars with higher CO2 emissions.

Capital allowances on cars

The government’s efforts to promote environmentally friendly vehicles are reflected in the capital allowances available for cars.

New and unused cars with zero CO2 emissions are eligible for a 100% first-year allowance, while cars with CO2 emissions below 50g/km can claim an 18% WDA in the main pool.

Vehicles with higher emissions will be placed in the special rate pool, with a 6% WDA rate.

It’s important to note that if a car is used for both business and private purposes, the capital allowances must be restricted to the proportion of business use.

Vehicle Scrappage Schemes:

In some regions, local authorities have introduced clean air zones, accompanied by scrappage schemes that provide cash grants to encourage the replacement of older, high-emission vehicles.

If you participate in such a scheme, the grant and any proceeds from scrapping the vehicle will be treated as ‘sale proceeds’ for capital allowances purposes, which can impact your tax position.

Claiming capital allowances

How you claim capital allowances depends on your business structure.

• If you are a sole trader you can claim capital allowances on your self assessment tax return.
• If you are in a partnership business you can claim them on your partnership tax return.
• If you have a limited company you can claim them on your company tax return.

For self assessment capital allowances should be included in your tax return within 12 months after the 31 January self assessment filing deadline.

Your capital allowances will reduce your taxable profit and your tax bill will be worked out accordingly when HMRC receives your tax return.

Does being VAT registered affect a claim for capital allowances?

If your business holds VAT registration you typically have the ability to reclaim the VAT paid on an item that you are claiming capital allowances on.

This allows you to recover the VAT via your VAT return and apply the annual investment allowance on the remaining amount.

What happens if I sell an asset that I’ve claimed capital allowances on?

When you sell an asset (asset disposal) on which you have previously claimed capital allowances, the proceeds from the sale must be deducted from the balance of the main writing down allowance pool.

If the sale proceeds exceed the remaining pool balance, a ‘balancing charge’ will be generated, which must be added to your trading profits rather than deducted from them.

Tips for maximising your capital allowances

To ensure you’re maximising your capital allowances you can consider the following strategies:

1. Prioritise the annual investment allowance: Whenever possible, aim to claim the AIA, as it can provide the most generous tax relief by allowing you to deduct the full cost of eligible assets in the year of purchase.
2. Carefully plan asset acquisitions: Time your purchases of qualifying assets to coincide with the start of a new tax year, allowing you to claim the AIA or WDA in the current period.
3. Review your asset mix: Regularly assess your business’s asset portfolio and consider replacing older, less efficient equipment with newer, more environmentally friendly alternatives to take advantage of any favorable capital allowances on offer.

Evidence for capital allowance claims

All claims for capital allowances should be backed up with HMRC compliant evidence meaning you must maintain strong records and documentation including relevant case law and legislation.

If HMRC were to review your capital allowances claim they will expect to see detailed information about the asset(s), their associated costs, and the conditions for eligibility for the applicable allowances.

Other types of capital allowances

Plant and machinery allowances cover many of the common qualifying costs for businesses but other capital allowance schemes exist for expenditure on more niche expenditure.

HMRC can accept capital allowance claims on research and development, renovating business property, structures and buildings, patent rights, intellectual property, extracting minerals, and dredging allowances.

Capital allowances guidance

Capital allowances are a powerful tax saving tool for self employed businesses but navigating the complexities can be a daunting task.

While the basic principles of capital allowances may seem straightforward, the practical application can often be more complex.

Consulting with a tax professional or a qualified accountant can help ensure you’re claiming all the capital allowances you’re entitled to and stay up to date with the latest changes in legislation.