What is Capital Allowance? Your Tax Questions Explained

Your annual business tax bill can be crippling if you don’t know how to claim for reliefs and allowances.

There are many different types of tax relief available for businesses, such as offsetting professional fees on your tax bill.

Did you know, however, that you can claim relief for your buildings and large expenditures, too? Capital allowance relief covers commercial properties, vehicle purchases, building alterations, and much more.

Read our quick guide to make sure you’re claiming as much tax relief as you can!

What Is a Capital Allowance?

A capital allowance is tax relief based on the amount of money invested in business assets within the tax year. Not every investment is a capital allowance, however.

Some expenses will fall under a different tax relief system, such as business expenses, while others cannot be claimed at all.

The amount of money invested in a tax year that qualifies for the relief is then offset against the annual tax bill of a business. This means that the company’s tax is reduced.

Who Are Capital Allowances For?

Any business model can use capital tax relief on their annual tax return. You can be a sole trader, a limited company, a partnership, or a social enterprise.

Some businesses will be able to claim much higher capital allowances than others. This is due to the amount of money invested per year in capital: once capital is claimed in one tax year it can’t be claimed the following year.

If, however, the capital investment amount is higher than the annual profits, these losses can be rolled over to the following year’s tax bill. The amount already claimed for in the first year is not allowable as an expense in the following year.

For example, if you buy commercial premises for $120,000 without any loans, but only turn over $100,000 in the same tax year with profits below that amount, the outstanding losses can be rolled to the following tax year.

What Is a Business Expense Versus a Capital Allowance?

It’s easy to confuse capital allowance relief with business expense allowances.

The simple way to think of the difference is this: a business expense is incurred for the day-to-day operation of a business. Capital expense is a one-off financial investment to benefit the business.

A business expense could include:

  • Marketing expenses
  • Professional and banking fees
  • Loan interest repayments
  • Membership of professional bodies
  • Education and training
  • Small office equipment and stationery
  • Utility bills and rent
  • Vehicle mileage and maintenance

These expenses could be regular, such as monthly utility bills, or a one-off like an annual membership to a professional body.

Capital expenditure, however, includes items such as:

  • Commercial premises
  • Fixtures and fittings
  • Vehicle purchase (but not leasing)
  • Machinery purchase
  • Wear and tear (depreciation) of machinery
  • Refurbishment, fit-out, or renovation

So while your capital investment will benefit the business for an ongoing basis, the investment amount is considered a one-off expenditure. Any continuing expenses from your capital investment, such as vehicle maintenance, can be claimed as a business expense in current and future tax years.

Remember to keep clear accounts for at least six accounting years for your business. If the IRS wants to audit or investigate your business, it’ll need to see all receipts, property deeds, and evidence to reconcile your balance sheet.

If you’re unsure whether your investment counts as capital, you can use a capital allowance review service for a full audit of your investments. A professional eye will help you to maximize your tax relief opportunities.

First Year Allowances

Starting up a business takes a lot of financial investment. The tax office recognizes that this exceptional expenditure in the first year of trading will affect profits.

Businesses can claim the full cost of most capital investment, such as machinery or vehicles, using their allowances. On top of this is the First Year Allowance, which provides additional support and relief for the investment made in the first year of business operation.

Selling an Item After Claiming Tax Relief

For the purposes of tax calculations, you are considered to have disposed of an asset if you have sold it, gifted it, swapped it, or no longer use it for the business. The resulting profit is called a capital gain.

Once you have claimed capital allowance for an asset it is essential to keep a record of this, as it will affect your future tax relief if you dispose of the same asset later on.

When you dispose of an asset that you have previously claimed 100% capital allowance on at the time of purchase you need to add this cost to your annual profits.

There is a different process if you either have sold at a loss, or have other outstanding allowances on which your item can be offset.

The items you can claim tax relief for will often fall into ‘pools’, each with a different annual percentage of tax allowance. If the asset you dispose of is within a tax asset pool, and you originally claimed 100% of the purchase cost as an allowance, you must offset the profit of sale against the balance of the pool.

Buying Commercial Property

The tax relief that you can claim on a commercial property depends on what the seller has already claimed.

If, for example, the office kitchen has just been refurbished and the seller has not claimed 100% capital allowance for this, you may be able to claim some costs. If they have already claimed allowances on the property, this will affect what you have claimed.

It’s essential that you are clear on what has, and hasn’t, been claimed for capital tax relief prior to signing any contracts. You could inadvertently miss out on tax relief options if the previous seller has already made claims.

When you sell your commercial property, you can apply capital gains allowances for additional relief. You can also claim business rollover relief if you use the profits from selling one asset to purchase another capital asset.

How Do I Claim Tax Relief?

Your capital allowance claims need to be done on your annual tax return. Make sure you keep records of all payments, and separate out your capital and business expenses on your return.

Getting things in the wrong place, missing receipts, or incorrect figures could all lead to a huge tax bill. If you’re not confident with completing a tax return, it’s time to hire an accountant!

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