A capital allowance is the tax equivalent of depreciation. For example, a business buys a lathe for £10,000 and believes the lathe has an estimated useful working life of 10 years. The business may choose to depreciate the asset at the rate of £1,000 a year until it has a net book value of zero after 10 years.
Claiming capital allowances
In practice, most capital allowances are concerned with plant and machinery. However, capital allowances can also be claimed for:
Renovation of business premises
Research and development
Patents and know-how
Cemeteries and crematoria.
There are no capital allowances for land and buildings, although certain fixed plant and machinery within a building may be eligible. The government has also announced that there will be some special capital allowances for enterprise zones in assisted areas.
Defining plant and machinery
Machinery is any device with moving parts. It does not have to be connected to any form of power. For example, a locking mechanism is machinery. Plant is equipment which a person uses to conduct their business. It does not include the premises in which a person conducts their business. This has led to some fine distinctions.
Plant must have an expected life of at least 2 years and be required for the functions of the business. Some small items, such as replacement loose tools, may be regarded as revenue expenditure. This means that you are able to claim tax relief immediately and not over many years. The exact scope of what comprises plant can at times be very marginal yet have a big impact on the tax you pay. If expenditure qualifies for a capital allowance you will receive tax relief on the whole amount, albeit over many years. If an item does not qualify for a capital allowance it can mean that you do not receive tax relief for it at all.
Calculating capital allowance
There is an annual investment allowance (AIA) which may be claimed against most forms of allowable plant and machinery. The main exceptions are for ordinary cars and plant and machinery purchased during a company’s final trading period. The allowance is currently £500,000 but is due to reduce for expenditure after 31 December 2015. There are also some instances when a first year allowance (FYA) may be claimed for the whole cost, such as for certain environmentally-friendly plant.
If plant and machinery qualifies for an allowance its value (after any AIA or FYA) is added to either the Main or Special Rate pool (unless tax law requires it to be calculated separately). Separate calculations are needed for certain long-life assets (those with an expected life of 25 years or more), some cars and (if you choose) short-life assets. There are 2 general pools: 1 at a high rate and 1 at a lower rate. Capital allowances mean that the whole cost of an asset will eventually be allowed for tax. A lower rate consequently means that this process will take longer.
The higher rate pool attracts a writing down allowance of 18% a year; the lower rate pool at 8% a year. Where you acquire assets for both pools it is therefore often preferable to use the AIA against the assets that attract the lower rate. Long-life assets must be included in the lower Special Rate pool.
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