What is capital allowance?

You can claim certain business purchases against your taxable profit, which reduces the amount of tax your company has to pay. The purchases you’re allowed to write off are as your capital allowances.

In this article, we’re going to look at:

• What is capital allowance?
• Why should you claim capital allowance?
• What can you claim as a capital expense?
• How do you claim capital allowance expenses?
• What alternatives are there?

Capital allowances are expenditures you can claim against your taxable income to reduce the tax your business pays.

To claim an expense under this category, you need to prove that the purchase was essential for running your business.

Your capital allowance reduces your tax bill. By paying less in tax, your business should have more expendable income and a better cash flow. 

As a general rule, you can write off large capital purchases for your business as part of your capital allowance. This can vary depending on the type of business you run, but usually covers the following:

• Vehicles
• Property
• Equipment
• Machinery

The type of business you run changes what counts as a capital expense. If you want something to be marked as a capital expense, then it has to be needed to run the business. 

For example, if a hair salon bought hairdryers, that would be allowed as part of the capital allowance. But if a food truck bought a hairdryer, that wouldn’t be allowed. 

It’s worth mentioning that you may not always be able to claim the full amount as part of your capital allowance. For instance, if you used your mobile phone for business, you could only claim the calls specifically for the business. You might even have to prove they were business calls. 

For something to be considered a capital expense it has to be fully purchased and essential to the business. You can’t claim on:

• Anything you lease – like vehicles or equipment
• Anything for entertainment – like a TV or karaoke machine
• Buildings – including parts of buildings
• Lands and structures

For more information, read our other guide ‘What can I claim for being self-employed’. 

Claiming your capital allowance is part of your Self-Assessment tax return. You can fill out this form online and report your expenses and claims there. 

Some costs can count under first year allowances, if you buy and claim them in the first year of running your business. 

Your Self-Assessment only comes once per year, on January 31st. 

Capital allowance and traditional accounting may not be for everyone, and if you’re wondering about alternatives you may be interested in cash basis accounting. 

Sole trader or partnership businesses earning under £150,000 a year may prefer to use cash basis accounting instead of traditional accounting. 

This method of accounting works by only declaring your business’ income and outgoings when money exchanges hands. 

At the end of the tax year, you would only pay Income Tax on the money you received during the tax year. 

Cash basis accounting isn’t perfect, though, especially when your business is more complex. 

For example, if you need a bank loan you may be asked for a copy of your accounts in traditional accounting. Not having this readily available might mean your business doesn’t get the loan. 

If you have high levels of stock, then you might be holding onto it for a while. If you sell it in a different tax period to buying it, you might find that you’re paying a lot more income tax than if you were using traditional accounting. 

For more information, check out these guides:

• What is cash basis accounting?
• Should small businesses use cash or accrual accounting?

The Annual Investment Allowance (or AIA) works similarly to Capital Allowance, but there are a few differences. The biggest difference being that AIA doesn’t allow for any purchases made before the business was started.

That means any vehicles or equipment that you bought ahead of time is unable to be claimed as an expense. 

Another major difference is that people who run multiple businesses are only allowed one AIA across all their businesses. While this means that some businesses may struggle, it also means that your newest business can get a boost. 

So now you should understand what a capital allowance is, and why it’s best for your business to use it as much as possible. To get the most from your capital allowance though, you’ll have to be aware of all your business’ expenses.

Keeping track of your financials and taxes can be tricky when you’re trying to figure out what counts as a capital allowance. Instead of doing it yourself, you can save a lot of time by using accounting software.

Certain accounting softwares, like the Countingup app, have automatic expense categorisation to help give a better understanding of your outgoings. 

Start your three-month free trial today.