Introduction to Capital Allowances

March 2022

 

Background

Depreciation of fixed assets charged in the accounts is not allowable in computing taxable profits. Instead, the UK government introduced capital allowances which is a form of tax relief that allows businesses which pay tax in the UK to deduct from their taxable profit (before calculating their tax liability), the value of their qualifying capital expenditure on assets such as equipment or buildings.

Despite constant changes both historically and recently, capital allowances as we know it today is based on the system introduced in Income Tax Act 1945, to incentivise the reconstruction of British industry after the second world war. The current legislative framework for claiming capital allowances in contained in the Capital allowances Act 2001. Understanding case law precedents and HMRC guidance is also key in identifying qualifying expenditure.

Capital allowances can be claimed not only by companies, but also partnerships, individuals and overseas investors which carry out qualifying business activities such as a trade, property business, furnished holiday let, etc.

Types of capital allowances

Capital allowances is a vast topic and there are various forms, types and categories. The most common form of capital allowances is the plant and machinery allowances.

Plant and Machinery Allowances (PMA)

PMA provide tax relief on capital assets such as business equipment qualifying as plant and machinery. Furthermore, there are three main types of PMA as follows:

  • First-year allowances (FYA): This allows a full deduction of the costs incurred on certain qualifying capital assets in the form of plant and machinery, during the (first) year the spend was incurred. Hence it is called “first year” allowances.
  • Annual investment allowances (AIA): This allows a full deduction up to a certain annual limit in respect of the costs incurred on certain qualifying capital assets in the form of plant and machinery, during the year the spend was incurred. The current annual limit is £1m.
  • Writing down allowances (WDA): This allows tax deduction at a reducing balance basis annually. The WDA has two pools or rates which includes the main pool (MP) rate of 18% on assets such as business equipment and furniture. There is also the special rate pool (SRP) of 6% on assets such as heating, ventilation, and air-conditioning systems. Some categories of WDA such as the following exist:
    • Integral features (IF): These relate to lifts, heating, air-conditioning, electrics, lighting, water systems, etc.)
    • Short-life assets (SLA): These relate to assets with useful life of not more than 8 years)
    • Long-life assets (LLA): These relate to assets with useful life of at least 25 years.

The rate of tax deduction on the above categories is MP for SLA claims, and SRP for both IF claims and LLA claims.

Where FYA and AIA does not apply, tax relief on PMA would typically default to WDA.

Structures and Buildings Allowances (SBA)

SBA was introduced on 29th October 2018 (operative date). It is available on structural and similar building related works like walls, floors and roofs, in respect of a non-residential business activity. It is only claimable at 3% straight-line deduction annually. SBA is available where the construction work commenced (and its agreement entered into) on or after the operative date. Generally, except for land, the part of the asset or property that do not qualify for PMA may potentially qualify for SBA, assuming the operative date requirement above is met. To be able to claim SBA on a qualifying second -hand building, the claimant would need to be in a possession of a compliant “Allowances Statement” obtained from the vendor of the building to confirm certain legislative basis of claim.

Research and Development Allowances (RDA)

RDA is available in respect of assets used in the process of carrying out research and development (R&D) such as building, equipment and furniture. The benefit is claimed in full at 100% in the year the spend is incurred. Less than 100% can be claimed in that year, but the balance cannot be claimed later.

RDA is only available for businesses carrying out the qualifying activity of a trade. The tax relief is claimed from when the trade begins if the qualifying expenditure was incurred prior to that.

Other forms of capital allowances

Other forms of capital allowances such as mineral extraction allowances and dredging allowances exist. There are also other capital allowances schemes such as Business Premises Renovation Allowances (BPRA) in respect of disadvantaged areas and Enhanced Capital Allowances (ECA) in respect of energy and water efficient equipment, which have in recent years been repealed. It is also worth noting that there are other capital allowances related tax relief such as, land remediation relief (available in respect of removal of contamination in land and buildings); and capitalised revenue deduction (available in respect of repairs and like for like replacements).

How to claim

Most accountants and tax compliance advisors will typically have the knowledge to assist in making capital allowances tax relief claim on easy to identify business equipment such as IT kit, furniture, machines etc. For capital expenditure on less obvious qualifying assets such as those relating to buildings or large-scale industrial / engineering plants, the skills and services of a specialist capital allowances advisor would typically be required in order to maximise the tax relief benefit.

The tax relief is obtained by introducing the claim into the tax return submission for the relevant accounting period. For registered companies, this would be the company tax return (CT600). For partnerships, this would be the partnership tax return (SA800), while for sole traders, it will be the self-assessment tax return (SA100/SA200). If the tax return for the relevant accounting period has already been filed with HMRC, the claim may be filed by amending the tax return if it is still available for amendment. Alternatively, the claim can be introduced into the tax return for any future accounting period.

The benefit of the tax relief claim comes as a tax saving by default. I.e., reduction in tax liability. In some cases, when the business is loss making or does not have sufficient income or profit to absorb the tax relief, it is possible to do a loss carry back. The loss carry back to a prior profitable period will generate a cash refund from HMRC due to overpaid tax. It may also be possible to surrender the losses for a tax credit from HMRC in respect of qualifying expenditure on certain types of assets.