Capital allowances are an often overlooked area of UK tax law that can provide substantial tax relief benefits for businesses and landlords. With careful planning and execution, capital allowances can lead to increased cashflow and long term tax savings. This guide will explore what exactly capital allowances are, who can claim them, the different types available, how to calculate and maximize your claim, and what the latest changes in legislation means for taxpayers.
What Are Capital Allowances?
Simply put, capital allowances enable businesses and landlords to obtain tax relief relating to capital expenditure – that is, the purchase of fixed assets such as equipment, machinery, and vehicles. Much like depreciation in accounting terms, capital allowances acknowledge that these assets decline in value over time. Therefore, taxpayers do not have to pay tax on the full purchase cost in the year of purchase.
The concept effectively spreads the tax relief on capital expenditure over several years, in line with accounting depreciation. This preserves cashflow for the business or landlord.
Capital allowances apply across the UK, with slightly different rules applicable in Northern Ireland.
Who Can Claim Capital Allowances?
Capital allowances can generally be claimed by:
- Companies subject to UK Corporation Tax
- Sole traders and partnerships subject to Income Tax
- Landlords receiving rental income – typically on fixtures within a property
- Specified professional people like doctors, dentists, nurses, and engineers
Allowances cannot be claimed by:
- Hobby businesses not generating taxable profits
- Charities and not-for-profit organisations
So the main recipients tend to be profit-making businesses incurring material expenditure on fixed assets. Landlords can also benefit where they have upgraded their properties.
The Main Types of Capital Allowance
There are three main categories of capital allowance in the UK tax system:
1. Plant and Machinery Allowances
These are by far the most common type of allowance claimed. They relate to spending on most forms of plant and machinery assets. Examples include manufacturing equipment, vehicles, office IT equipment, and machinery used in a process or trade.
The majority of plant and machinery expenditure qualifies for special 18% pa writing down allowances. Other assets and expenditure qualify for 6% pa or 8% pa allowances, or a single year allowance.
2. Structures and Buildings Allowances
These allowances were introduced in 2019 and relate to spending on constructing or renovating non-residential structures and buildings used in the business over a 50 year period. Hotels, care homes, and factories are common examples.
An annual 3% capital allowance can be claimed on qualifying expenditure, providing steady tax relief for many years.
3. Research & Development Allowances
Spending on facilities and equipment for research and development activities can qualify for 100% first year capital allowances. This encourages innovation and cutting-edge development.
There are specific requirements around qualifying R&D expenditure which determines eligibility for relief under the R&D schemes.
How Are Capital Allowances Calculated?
Working out tax relief entitlement starts with analyzing capital expenditure by fixed asset type to identify qualifying spending. Accounting depreciation is ignored for tax purposes. Only assets used fully or mainly for the business or property qualify.
Once qualified expenditure is determined, the next step is applying the relevant writing down allowances rate – typically 18%, 8% or 6%. Other enhanced allowances may apply to expenditure on energy/water efficient assets and new zero emission cars.
Part periods also need factoring in – full annual allowance reliefs normally only apply to assets owned for a full 12 months.
In terms of valuation, machinery and equipment are usually pooled by tax year of acquisition, then tracked by tax written down value. Other assets like buildings follow prescribed statutory rates, so don’t go into pools.
The total allowance is then deducted when calculating taxable profits each year – saving 19% corporation tax or 20%-45% income tax depending on circumstances.
Maximizing Your Claim
Withsound pre-planning, it is possible to maximize capital allowances tax relief beyond the default statutory amounts. Areas to focus on include:
Enhanced Allowances – various schemes boost first year allowances for investment in approved sectors like energy/water technology, environmentally friendly equipment and cars.
Timing of Expenditure – tax relief can be accelerated by completing qualifying expenditure just before the end of your accounting period rather than just after. Careful timing of major investment in plant can be very rewarding.
Degrouping Charges – watch out for excess capital allowances claims being clawed back on leaving a group of companies. Creative workarounds are sometimes possible.
Sheltering Higher Profits – allowances give greater savings at higher marginal tax rates, so allocate expenditure to peak profit years if feasible.
For major projects, detailed numerical forecasts projecting the capital allowances over future years are essential.
Recent Important Legislative Changes
Capital allowances is a dynamic area driven by wider government policy objectives like stimulating investment, supporting “green” initiatives and promoting growth sectors.
Some notable recent developments include:
130% Super-Deduction – this was introduced in March 2021 as a temporary measure granting first year allowances of 130% on qualifying plant and machinery. This hugely boosts cashflow where major investments is taking place.
30% First Year Allowances – Certain assets like electric vehicle charge points, energy/water efficient plant and certain cars qualify for enhanced 30% first year allowances until 2023 at least. Requirements keep evolving so worth confirming what qualifies.
Residential Use Restrictions – From April 2020 capital allowances relief has been tightened up in cases where properties like hotels and care homes have some element of private residential occupancy. Relief may be restricted if over 50% of occupancy is private.
Professional advice is essential to navigate the latest rules and maximise reliefs. Capital allowances legislation sees frequent updates and changes.
Conclusion – A Key Area For Tax Planning
In summary, capital allowances provide very valuable tax relief on capital expenditure for businesses and landlords. Yet many still fail to fully utilize available allowances or employ strategic tax planning techniques to enhance claims.
With assets valued on the UK’s tax balance sheet now exceeding £5 trillion, the scope for unlocking allowances through detailed reviews is enormous. Specialist advice combined with professional planning around expenditure and disposals can optimize relief – lowering tax bills both now and into the future.
In the current tough economy where costs are rising sharply, the cashflow and tax savings from capital allowances shouldn’t be overlooked. All qualifying entities are advised to assess current claims and ensure this area forms part of overall strategic tax planning going forward.