Capital Allowances and the Annual Investment Allowance

When your business spends money on most things like rent, wages or stationery, the cost is instantly tax deductible in full. In other words, if you spend £10,000 on rent during the year, your taxable profits will be reduced by £10,000 and your tax bill will fall by £4,200 if you are a higher-rate taxpayer (£10,000 x 42%).
However, when your business buys assets – things that are not used up during the year but last for several years – you normally cannot claim a full tax deduction in the year of purchase. Instead, you can claim, say, 18% per year.
This 18% tax deduction is known as a capital allowance and is designed to compensate your business for asset depreciation due to wear and tear.
Capital allowances are given instead of commercial depreciation charges included in your accounts, which are not allowable.

What Sort of Spending Gets Capital Allowances?

Generally speaking it is spending on ‘plant and machinery’ that qualifies for capital allowances. Plant and machinery is a somewhat old-fashioned term and there is no definition of it in the statute books.
For a typical business in the service sector, plant and machinery includes things like:

  • Computers and office equipment
  • Office furniture
  • Cars and other vehicles

Businesses that ‘make things’, for example those in the manufacturing sector or construction sector, usually own specialist equipment and tools.
These assets also attract capital allowances, although there are far too many to mention.

Spending that Does Not Qualify for Capital Allowances

Almost every asset you buy for your business will attract capital allowances. There are very few exceptions, the most notable ones being:

  • Stock in trade (Stock in trade is simply the inventory or merchandise belonging to the business: the items it sells.)
  • Buildings and land (Buildings and land also do not qualify for capital allowances because these assets tend to rise in value over time, rather than depreciate.)

Although buildings and land do not qualify for capital allowances, certain ‘integral features’ inside commercial properties do qualify. Integral features include all the existing wiring, lighting, plumbing, heating and air conditioning in any commercial property you buy for your business.

Tax relief is also available when you spend money on certain property fixtures, including new fitted bathrooms, toilets, showers, and kitchens in any commercial property. This is as close as you can get to claiming tax relief for the building itself.

Annual Investment Allowance

Although you normally cannot claim a full tax deduction for your capital spending in year one, at present UK tax legislation contains a generous ‘annual investment allowance’, which provides 100% tax relief for spending on most types of plant and machinery in the year they are bought.

The allowance is available for purchases of both new and second-hand assets and is available to all types of business: sole traders, partnerships and companies alike.

At present, the annual investment allowance allows up to £250,000 of qualifying capital spending per year to benefit from 100% tax relief. The amount that this has been set at has been constantly changing over the past few years. Prior to April 2012 it was set at £100,000 per year. In April 2012 it changed to a less generous £25,000 but then there was a change in heart by the Chancellor and it was increased tenfold to £250,000 from 1st January 2013.

This new rate of £250,000 has been set for two years. So, failing a further change of heart (which would be unlikely due to a commitment being made-but you never know) then this will give businesses £500,000 to spend on capital items in the next two years and to receive the full tax deduction in full in the year that it was incurred. What amount this allowance will be after this time period is anyone’s guess so it is important that if you want to take full advantage of this generous tax break that you plan your capital spend appropriately to ensure that you take advantage of this while it lasts.
It is worthwhile keeping an eye out on future budgets and autumn statements to see if the Chancellor changes it again. If he does, and reduces it, then this may mean it is worthwhile bringing forward some expenditure to ensure that you get the full benefit.