What you need to know about capital allowances and depreciation.
All businesses rely on assets to function. Some companies are more reliant on physical assets than others and wouldn’t be able to trade without them. When a piece of equipment has come to the end of its useful life, it needs replacing. Of course, the replacement, whether new or second-hand, can be a costly investment, so what implications does this have for your accounts and your tax bill?
What’s your biggest asset?
Assets can be monetary, physical, or non-physical, but they’re vital to a business’s survival whatever form they come in. Purchasing new cars, machinery, or equipment, can be a significant expense. And even though financially speaking, you still have to pay out (after all, there’s no such thing as a free lunch), you can reduce the impact of these purchases on your profits in two ways. First, there’s depreciation.
And depreciation is?
As soon as you purchase an asset, you can no longer sell it as new. And, combined with any wear and tear incurred through use, its monetary worth decreases. For example, a well-used, two-year-old laptop is worth far less than the same model brand new. This reduction in worth is called depreciation.
You can calculate the annual depreciation of an asset by one of several methods. Doing so means you can understand how much an item has set you back each year of its lifetime, and therefore work out the true profitability of your business.
The depreciated costs of any asset are an expenditure you should include in your annual business expenses. But, although depreciation is a vital piece of information for calculating profits, it isn’t something you can claim tax relief against. Instead, we come to our second point and what HMRC uses to reduce your tax liability: capital allowances.
What are capital allowances?
A capital allowance is an allowance or reduction in taxable profits that any business is entitled to when an asset (or assets) is purchased. There are two types of capital allowance: the annual investment allowance (AIA) and the first year allowance; there’s also a similar practice: the writing down allowance. What you claim will depend on the type of asset bought and how much you are claiming.
The AIA, meant to reimburse the purchase of what is known as ‘plant and machinery, has a £1m limit, meaning if you’ve bought a qualifying piece of equipment, you can reduce your tax bill by the full purchase amount, providing it is £1m or less. Let’s say your profits are £2m, and within the last tax year, you bought an asset for £250,000. An AIA allows you to reduce your tax liability by 100% of the asset’s value, which means before other deductions and your tax-free allowance, your tax liability would be calculated on £1.75m (instead of £2m).
What can I claim?
There are rules and regulations around what you can and cannot claim with the AIA and first-year allowance. For example, you cannot claim AIA for cars; instead, you must use first-year allowance or writing down allowance. And there are some things you cannot claim for at all, like buildings, rentals, or land.
Your accountant, who should already be working out your depreciation expenses, will be able to tell you what and how much you can claim. If they can’t, get in touch! We can help you understand your true profits as well as get the tax relief you’re entitled to.
Interested? Email or call us on 01482 408585. Alternatively, schedule an appointment and visit us at 277 Anlaby Rd, Hull HU3 2SE.