All you need to know about Capital Allowances for the Self Employed
As a self-employed person in the UK, it’s important to understand how you can reduce your tax bill through capital allowances. Capital allowances are a form of tax relief that allows businesses to claim back the cost of certain types of capital assets, including equipment, machinery, and vehicles.
In this post, I have summarised the main information you should know if you are considering purchasing an asset for your business. Although this article is well-researched, you shouldn’t consider it as financial advice: do seek professional advice should you require specific support to understand how to claim this particular type of tax relief.
What we’ll cover
- What are capital allowances in taxation?
- What kind of capital allowances for sole traders are there?
- How to claim capital allowances
- Can capital allowances increase a loss?
- Additional tips for claiming capital allowances
Disclosure: There are some affiliate links below and I may receive commissions for purchases made through links in this post, but these are all products I highly recommend. I won’t put anything on this page that I haven’t verified and/or personally used.
What are capital allowances in taxation?
They are a type of tax relief available to UK businesses and sole traders that invest in certain types of assets.The relief is designed to allow you to deduct the cost of these assets from your profits before tax is calculated. This means that your business can reduce its taxable profits, which in turn reduces the tax bill.
In case you don’t know what assets are: an asset is something that you own that has value, such as money in a bank account, a car, a house, or a computer. Assets can be used to generate income or increase in value over time, and benefit you financially. Many items that you buy may qualify as an asset: for example, if you are a musician and you buy a very expensive keyboard that you plan to use for your next EP, you can count it as an asset.
What kind of capital allowances for sole traders are there?
There are two main types of capital allowances:
- Annual Investment Allowance (AIA): this allowance allows you to claim 100% of the cost of qualifying assets, up to a certain annual limit. The current AIA limit is £1 million, but this is subject to change.
- Writing Down Allowances (WDA): this allowance allows you to claim a percentage of the cost of qualifying assets each year. The percentage varies depending on the type of asset and its expected useful life. To claim writing down allowances, group items into pools depending on which rate they qualify for (more on this further down in the article).
Examples of assets that qualify for capital allowances
Let’s take a closer look at some examples of assets that qualify for capital allowances:
- Computer equipment: if you purchase a new computer for your business, you may be able to claim the full cost of the computer as a capital allowance. This means that you can deduct the full cost of the computer from your taxable profits in the year you purchase it.
- Machinery: if you purchase a new piece of machinery for your business (for example a sewing machine for you to streamline your clothing production), you may be able to claim the cost of the machinery as a capital allowance. Depending on the type of machinery and how it is used, you may be able to claim the full cost of the machinery in the year you purchase it, or claim a percentage of the cost each year.
- Vehicles: if you purchase a new car for your business (eg: you want to sign up to become an Uber driver), you may be able to claim the cost of the vehicle as a capital allowance. However, there are restrictions on the types of vehicles that qualify, so it’s important to check the rules before making a claim.
How to claim capital allowances
As a self-employed person, claiming capital allowances as part of your Self Assessment tax return is a fairly straightforward process. Here’s a step-by-step guide on how to claim capital allowances.
Step 1: Identify the assets that you have bought within the financial year in question.
Make a list of the assets you have purchased in the year. These can include equipment, machinery, vehicles, and certain types of buildings and fixtures.
Step 2: Determine which assets qualify for Capital Allowances
Once you’ve established your business is eligible to claim capital allowances, the next step is to identify the assets that qualify for the capital allowance tax relief.
Qualifying assets include:
- Plant and machinery: this category includes any equipment, machinery, and tools that you use for your business, including computers, furniture, and office equipment.
- Buildings and renovations: you may be able to claim capital allowances for certain renovations or improvements to your business premises, including electrical and plumbing installations, heating and air conditioning systems, and certain types of fixtures such as kitchen and bathroom fittings.
- Vehicles: you may be able to claim capital allowances for cars, vans, lorries, motorcycles, and other vehicles that are used for business purposes.
- Research and development: if you carry out research and development activities, you may be able to claim capital allowances on the cost of qualifying assets such as machinery, equipment, and software.
- Energy-saving equipment: you may be able to claim capital allowances on the cost of energy-saving equipment, such as LED lighting, solar panels, and wind turbines.
- Certain intangible assets: you may be able to claim capital allowances on certain intangible assets, such as patents, trademarks, and copyrights.
It’s important to note that not all assets qualify for capital allowances. For example, land and buildings that are used for residential purposes or are purely for investment purposes generally do not qualify. This means that, for instance, you might not be able to claim capital allowances on rental property.
Step 3: Calculate your Capital Allowances
For Annual Investment Allowance claims, calculations are easy: you just include 100% of the asset price as your capital allowance claim. For example, if you purchased a computer for £1,000 and are claiming the full cost as an Annual Investment Allowance, your relief would be £1,000.
For Writing Down allowances, you need to calculate the amount of relief you can claim. You must work out how much you can claim separately for each pool.
The 3 types of pool are the:
- main pool with a rate of 18%
- special rate pool with a rate of 6%
- single asset pools with a rate of 18% or 6% depending on the item
For a breakdown of which assets are in which pool, you can check HMRC’s guidance on WDAs.
Example: Let’s say that you want to become an Uber driver, so you purchase a car for £12,000 and you are claiming WDAs under the capital allowances scheme for business purposes. First, you need to determine the rate of the writing down allowance that applies to the car. This will depend on the type of car you purchased and its CO2 emissions. Let’s assume that the car is a regular petrol car with CO2 emissions of 140 g/km, and the rate of the writing down allowance is 18%.
Next, you need to calculate the annual allowance that you can claim. To do this, you simply multiply the cost of the car by the rate of the writing down allowance:
Annual allowance = cost of car x rate of writing down allowance
= £12,000 x 18%
= £2,160
So, in the first year of ownership, you can claim a writing down allowance of £2,160 against your taxable profits. In the second year, you will apply the same rate to the remaining balance of the cost after the first year allowance has been claimed, and so on until the cost of the car is fully written down.
Step 4: Include your Capital Allowances in your Self Assessment Tax Return
To claim capital allowances as part of your Self Assessment tax return, you’ll need to complete the relevant sections of the form. This will include providing details of the assets you’ve purchased and the amount of capital allowances you’re claiming.
Step 5: Submit your Tax Return and pay any tax due
Once you’ve completed your Self Assessment tax return, you’ll need to submit it to HMRC. If you’re filing online, the deadline is 31st January following the end of the tax year. If you’re filing a paper return, the deadline is 31st October following the end of the tax year.
If you owe any tax, you’ll need to pay it by the same deadline. If you’re not sure how much tax you owe, you can use HMRC’s online tax calculator to estimate your bill.
Can capital allowances increase a loss?
Short answer is: yes, they can. If you are breaking even or at a loss without factoring in your capital allowance deduction, then once you add it to your Self Assessment calculation, you will have an increased loss. However, you may be able to either bring that loss back, or carry it forward into, respectively, previous and future financial years, offsetting the profits from those years.
If you have incurred a loss, I highly advise reading this article on what happens if you make a loss, which includes detailed information about trade losses, and how/when you can offset them against past or future profits.
Additional tips for claiming capital allowances
- Understand the rules, and/or seek professional advice: there are different rules for different types of assets and different types of capital allowances. It’s important to understand these rules and make sure you are claiming the correct amount of relief. You may want to consult with an accountant or tax advisor to ensure you take advantage of all the available relief. My personal recommendation is to search for an adviser using Unbiased: this is a website thatacts as a search engine to match you with the most suitable finance advisor or accountant according to your needs.
- Don’t forget about disposals: when you dispose of an asset (ie: you sell it), you may be able to claim a balancing allowance or balancing charge. This is based on the difference between the sale price of the asset and the remaining balance of the capital allowance. Make sure to include any disposals in your tax return to claim the appropriate relief.
- Claim as soon as possible: it’s best to claim capital allowances as soon as possible after purchasing an asset. This ensures that you can deduct the cost from your taxable profits in the year of purchase, which can provide a significant tax benefit.
- Keep accurate records: it’s important to keep accurate records of the assets you’ve purchased and the amount of capital allowance you’re claiming. This will make it easier to complete your Self Assessment tax return and provide evidence to HMRC if necessary.
Conclusion
Claiming capital allowances can be a complex process, but it’s an important way for sole traders to reduce their tax bill and reinvest in their businesses. Capital allowances are an important aspect of Self Assessment tax returns, as they can significantly reduce the amount of tax you owe. By following the steps outlined above, you can identify which assets qualify for capital allowances, and use the capital allowance to reduce your tax bill.
Other articles you may like
- Pensions for Sole Traders: Everything You Need to Know
- How to Price Your Services as a Freelancer
- Self Assessment for the Self-Employed: How to Submit Your Tax Return
