How to reduce your tax bill with Capital Allowances
Posted on 22nd June 2022
How can you reduce your tax bill?
Capital Allowances are a great way for businesses to reduce the amount of tax they pay and, as such, have become an important part of business tax rules and regulations.
But… there’s always a but when it comes to taxes, right? Capital allowances are an incredibly complex area of tax deduction – not everything you purchase for your business can be claimed as a capital allowance, and there are different types of capital allowances, which all have different rules, amounts you can claim back, and thresholds to consider.
If Capital Allowances are so complicated, is it even worth claiming?
Any way to legitimately reduce the amount you must pay in taxes is worth doing, especially if you’re an independent, small to medium business or you’re self-employed.
Capital Allowances can reduce your tax bill significantly and some assets are even eligible to have their entire cost written off in a single year – which can make a massive dent in the amount of tax you’ll need to pay!
Not only that, but if you have allowances left at the end of one tax year, it can be carried over into the next year, reducing that year’s tax bill too. For example, if you buy a new asset with a taxable value of £150,000 but your tax bill for the year only comes to £20,000, the excess can be carried forward.
So, what are Capital Allowances?
We get asked this a lot when we mention capital allowances to our clients and, as we’ve mentioned, it is a complicated and confusing subject. Not every asset you purchase as a business is eligible for capital allowances.
Capital allowances (often called fixed assets) are things that HMRC consider to reasonably be expected to continue to be in use by the business for more than a year.
To simplify some of the terminology, capital allowances are basically designed to do two things for businesses:
They provide businesses with reasonable support towards the cost of wear and tear on capital assets.
They help encourage investment in assets that are considered to improve business productivity, encouraging business growth (which should be good for the economy).
So, you can only really claim capital allowances on assets that are kept and remain in use by the business. Leased items, such as leased vehicles, are not eligible for capital allowances (but you can still claim tax relief on these as a business expense).
There are also some exemptions to capital allowances as well. For example, you can’t claim capital allowance for land, buildings, or structures – and this includes things like doors or gates. You also can’t claim for assets that will only be utilised for entertainment purposes – so, unfortunately, you can’t claim for that banging stereo system you bought to play music in your shop or, according to HMRC, that brand spanking new yacht you spent millions on…
So what can I claim capital allowance on?
Despite the rules being different for some items, here is a list of common assets bought for a business that you can claim capital allowance on:
Cars, vans, trucks, and other vehicles
Machinery – such as CNC machines etc.
Computers, laptops, printers etc.
Office furniture such as filing cabinets, desks, office chairs etc.
These are all typical business purchases that would be eligible for a capital allowance claim and, as you can see, some of them can be expensive to buy, which means the capital allowance claim could significantly reduce your tax bill.
There are a few other things that are eligible for capital allowance, such as fixtures and fittings like decorating your business premises, renovating and installing kitchen facilities, or the cost of altering the business premises to ensure it is suitable for another asset, like machinery.
But that’s not the end of your capital allowance claim
In order to claim capital allowance against a new asset for your business, you need to work out its overall value.
Notice how we’ve said overall value as opposed to purchase price?
This is because the entire value, for tax purposes, of a new asset isn’t reduced to merely the cost to purchase it.
For example, the value of a new van for your business is quite simple to work out – it is, essentially, just the cost to purchase the vehicle plus any extras. That’s it.
But… if you were to purchase new CNC machinery for your business, you would also incur delivery costs. That new CNC machine will also need to be installed and programmed correctly, and you may even need to make significant alterations to your business premises to accommodate the large machinery.
All these associated expenditures can be added to the base cost of the new CNC machinery to work out the final value that you can claim tax relief against, because that is the total cost to ensure that asset is ready for use by the business.
That doesn’t sound like Capital Allowances are all that complicated
So far, so good. Right?
Well… you can also claim towards the ongoing costs associated with the assets you have purchased, although you can’t claim for servicing and the like as this is an expense. So, if you do any maintenance down the line to the machine, such as to upgrade it and make it work more efficiently or ensuring it lasts longer and continues to work for your business, then this can be claimed.
So, there’s that complication – you can’t claim servicing as a capital allowance, but you can claim maintenance that improves or extends the life of a machine.
There are also several different types of capital allowance that you can claim. What’s more, each different type of capital allowance comes with its own claim limits, thresholds, and rules!
What are the different types of capital allowance?
There are 5 types of capital allowance – AIA or Annual Investment Allowance, FYA or First Year Allowances, the super deduction (brilliantly named, we know), Special Rate allowances, and writing down allowances.
Depending on the asset you purchase, the value may qualify for one or more of these allowances, but there are rules as to what is eligible for each type of allowance that can be claimed as well as limits as to how much you can claim for each type of allowance.
Annual Investment Allowance or AIA
You can claim up to £1,000,000 of AIA in a single year, so this is a capital allowance definitely worth utilising. The annual limit for AIA is normally £200,000 but the government decided to increase it to £1 million until 31st March 2023 to stimulate more business investment.
You can use your AIA on a single asset or spread it out across several, but you can only claim annual investment allowance against a business asset that you have purchased within the financial period that the claim relates to.
Annual Investment Allowances are great for claiming tax back on 100% of a new asset’s value, and with the increase in the allowance’s limit, it’s worth taking advantage of.
First Year Allowance or FYA
With First Year Allowances, much like with Annual Investment Allowances, you can claim against 100% of the value of new business assets.
Unlike Annual Investment Allowances, First Year Allowances have strict criteria as to what kind of assets are eligible, but you can claim both AIA and FYA against qualifying purchases – and, even better, your claim won’t count towards your AIA limit!
The First Year Allowance exists to help encourage businesses to become more ecologically active, so assets that qualify for the allowance are usually environmentally focused.
Assets that you can FYA for include things like energy-saving or water-efficient equipment, zero-emission goods vehicles, cars with CO2 emissions that are 75gms/km or less, and specific types of vehicle refuelling equipment.
The super deduction allows certain types of businesses to claim tax relief on up to 130% of an asset’s value rather than the normal 100%.
The super deduction is a temporary allowance, much like the increase in the AIA’s limit, that businesses that pay corporation tax are eligible to claim against qualifying plant and machinery assets until April 2023. What’s more, there is no capped limit on the super deduction!
The downside is that only those that pay corporation tax are eligible to claim it, which means that limited companies are eligible but sole traders aren’t.
The super deduction can also be quite confusing when it comes to what’s eligible, and with corporation tax due to rise, it may or may not be worth investing more money in assets just to claim the super deduction.
Special Rate Allowance or SR
The special rate allowance allows you to claim tax relief on assets that don’t qualify for the main rate pool for other allowances, such as building alterations, cars with a CO2 emission over the thresholds for other allowances, and thermal insulation.
The SR allowance doesn’t have a limit for total tax relief claims, but you can only claim 50% of the qualifying cost in the first tax year, and then 6% for subsequent years.
Writing Down Allowances
If the assets you purchase either don’t qualify for the annual investment allowance or if you’ve used up all the AIA, then you can use writing down allowances as an alternative.
If you are claiming writing down allowances, any assets that you claim against will be allocated to a ‘pool’. Each pool has criteria, set by HMRC, that determines the rate of tax relief that can be claimed against it. According to HMRC, each pool reflects the depreciation and wear and tear that the assets within it can experience.
Still reading? Well done!
As you can see, capital allowances are a complex area of tax relief, and depending on your business plans and current circumstances, it is always worth getting professional advice before making any significant purchases for your business.
It can be easy to become excited by the prospect of paying less tax, but tax relief is just one aspect of good cash flow management. Purchasing assets now to take advantage of certain increases in tax allowances may not be the best decision in the long run.
If you need assistance with your taxes or would like advice on whether to purchase new assets and claim capital allowances, then get in touch – just give us a call on 01452 596 765 or email firstname.lastname@example.org.
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