What is a Capital Allowance?
A capital allowance is an expenditure a U.K. or Irish business may claim against its taxable profit. Capital allowances may be claimed on most assets purchased for use in the business, ranging from equipment and research costs to expenses for building renovations.
The classification of these assets determines whether full or partial value can be claimed, and whether the allowance is deductible in one year or over several. Once a business has calculated the amount of capital allowance expenditures that may be claimed during a taxation period, it should include this information on its tax return, which, in the U.K., is submitted to HM Revenue & Customs (HMRC).
- Both the U.K. and Ireland allow certain business expenditures to be deducted as capital allowances
- Some spending can be deducted from taxes in the year in which it is incurred, while other eligible allowances are spread over multiple years
- Eligible categories include equipment and at least some vehicles for company use
- Spending on non-durables, such as office supplies, is not eligible
Allowable Capital Allowances
Regulated by HMRC, the Capital Allowances Act permits U.K. businesses to claim deductions for a wide variety of expenditures. (This guide primarily covers the U.K. situation; the Irish regulations are discussed briefly at the end.)
The Plant and Machinery category includes such assets as equipment and cars, vans, and trucks. Some or all of the value of the items can be deducted from the company’s profits before paying taxes. Other capital allowances include research and development (R&D) costs, patents, and renovations to business premises. The following, however, cannot be claimed as capital allowances: leased items; buildings, including their doors, gates, shutters, water and gas systems; land and structures, including bridges, roads, and docks; and any item used for the purpose of business entertainment, such as a boat or entertainment system.
Types of Capital Allowance
The AIA allows businesses to deduct the full value of most items used solely for business purposes, up to the £1 million annual limit of the allowance (temporarily increased until Dec. 31, 2020). The tax deduction is claimed in the same taxation year as the item is acquired. Most plant and machinery can be claimed under the AIA except cars, gifts to the business, and any items purchased before they were used in the company.
A related type of capital allowance is the first-year allowance. Also known as as an "enhanced capital allowance," it is available over and above the standard AIA amount for certain assets purchased by a business. The deduction may only be made in the year of purchase, hence the name. The categories of items eligible for the first year allowance are energy- or water-efficient equipment, which includes certain types of new cars with low CO2 emissions, energy- and water-saving equipment, and new zero-emissions goods vehicles.
Using the Writing Down Allowance
If you do not claim all the AIA or first-year allowances you’re entitled to, you can claim part of the cost in the next accounting period using writing down allowances. A writing down allowance is spread out over a number of years and can also be used for assets that are not eligible for the other deductions, including cars, items received as gifts, or items that were owned prior to their use in business.
The percentage of the value that may be claimed is based on the type of item, and the rate deductible for business cars is dependent on the level of CO2 emissions. Typically, value means the price paid for an item. However, in cases where an item was a gift or was previously owned, the market value should be used in calculating deductions.
Rates for the Writing Down Allowance
Most items that are used for business purposes qualify for an 18% annual deduction of their value. Assets that are only eligible for an 8% deduction include integral features of buildings such as escalators or air conditioning, items with a long life (25 years or more), thermal insulation of buildings, or cars with higher CO2 emissions. With the exception of cars, HMRC advises that the business claim these assets under AIA rather than claiming as a writing down allowance, with only an 8% deduction rate, unless the AIA limit has already been reached.
Capital Allowances in Ireland
The Irish republic's capital allowances are structured similarly to those in the U.K. However, unlike the U.K.'s AIAs, allowances in Ireland that may be claimed in full during the year they are incurred are limited to those with specified environmental or health benefits.
A capital allowance of 12.5% a year for eight years may be claimed for spending on plant and machinery; motor vehicles; transmission capacity rights; computer software; and such specified intangible assets as patents, copyrights, trademarks, and know-how. Expenditures on industrial buildings may be claimed at 4% over 25 years for most industrial buildings.
A company can claim an Accelerated Capital Allowance (ACA) of 100% for the following: energy-efficient equipment including electric and alternative fuel vehicles; gas vehicles and refueling equipment; and equipment in a creche or gym provided by the company to its employees. The ACA can be claimed in the first year the asset is used in the business.