Capital allowances are tax-deductible expenses which take the place of depreciation in computing an individual or institution’s tax liability. Ever computed your tax liability manually by simply applying the rate of Corporation Tax to your accounting profit? Was that the tax liability which was eventually charged? Probably not and capital allowances may have had a role to play in this.

Let’s start with why depreciation is substituted for capital allowances in the first place. Depreciation is an accounting estimate which simply reflects the accountant’s judgement over the expected pattern of consumption of the benefits of a non-current asset over its useful life. The key words here are estimation and judgment. Those familiar with financial reporting are likely to be well acclimatized with the use of these in accounting terminology. Since depreciation is dependent on judgement, each firm is likely to have a differing depreciation policy on the varying classes of non-current assets which it holds ranging from Fixtures & Fittings, Plant & Machinery to more uniform ones such as Buildings. Varying depreciation policies yield varying accounting profits which would imply varying tax implications.

To iron out this discrepancy, HMRC disallows depreciation and instead allows sole traders, partners, and companies to claim what are known as capital allowances. At simplest level, capital allowances are segregated into 2 pools: Main Pool and Special Rate Pool. For simplicity, we shall assume the absence of other forms of allowances such as the Annual Investment Allowance, First Year Allowance or Enhanced Capital Allowance. The former enjoys a claimable rate of 18% whilst the latter only receives 6%. Both work in a similar manner to the reducing balance method of depreciation in that the relevant %’s are applied to the cost of the asset to compute the capital allowances in the first year. In subsequent years the % is applied to the cost minus capital allowances already claimed.

So why are there 2 separate pools?

The Main Pool composes of assets such as plant and machinery, vans, lorries, motor vehicles (limited to those with CO2 emission no more than 50 g/km) and even computer software. Also permitted for inclusion are Integral Features including but not limited to lifts, heating systems, solar shading, and water-cooling systems. In contrast the Special Rate Pool includes assets with a long life, generally defined as over 25 years, as well as motor vehicles with CO2 emissions above 50 g/km.

This list is not exhaustive, and the eligibility of an asset may depend on multiple other criteria as well but for a starting point, this blog provides a brief yet hopefully insightful analysis of capital allowances. I shall be covering further complications related to capital allowances in the next few weeks. To stay up to date with the latest tax knowledge and advances, join Cheylesmore Accountants today to optimize your tax affairs.