This article is of informative character only.
In accounting, capital allowance is a term that often crops up when dealing with fixed assets and their implications on income tax. Understanding capital allowance is crucial for businesses of all sizes, as it can significantly impact their tax liabilities and cash flow. In this article, we will discuss the concept, importance, and how it affects businesses.
What is Capital Allowance?
Capital allowance is a tax relief provided to businesses for the depreciation or wear and tear of their capital assets. These assets can include machinery, buildings, vehicles, and inteangible property. The idea behind capital allowance is to acknowledge that as these assets are used over time, they lose value and, therefore, a company can claim a corresponding deduction.
Importance of Capital Allowance
- Tax Reduction: Capital allowance allows businesses to reduce their taxable income by deducting a portion of the cost of acquiring or improving capital assets – which results in reducing their overall tax liability.
- Cash Flow Management: By reducing their tax liability, businesses can allocate more funds to operational expenses or invest in growth opportunities. This can have a significant positive impact on cash flow, especially for small and medium-sized enterprises.
- Encouragement of Investment: Capital allowance acts as an incentive for businesses to invest in new capital assets. This, in turn, can boost economic growth and job creation.
Types of Capital Allowances
- Annual Investment Allowance provides businesses with a 100% allowance on qualifying capital expenditures, up to a specific limit. This limit is set by the government and can change from year to year. It’s designed to encourage businesses to invest in capital assets.
- Writing Down Allowance allows businesses to claim a percentage of the asset’s remaining value as an allowance. The rate of WDA depends on the type of asset, with special rates for certain assets like cars and long-life assets.
- First-Year Allowance is a temporary incentive that allows businesses to claim a higher percentage of the asset’s cost in the first year of purchase. It’s often used to encourage investment in environmentally friendly assets, such as energy-efficient equipment.
- Balancing Allowance and Balancing Charge: These adjustments are made when the value of an asset changes significantly, either due to disposal or changes in its use. A balancing charge occurs when an asset’s value increases, and a balancing allowance occurs when it decreases.
Claiming Capital Allowance
To claim capital allowance, businesses must keep accurate records of their capital expenditures. Invoices and receipts must be archived in accordance with the law (digitally or in paper form) for a prescribed number of years. Companies can then report these expenditures in their annual tax return to calculate the applicable allowances.
It’s important to note that there are specific rules and criteria for claiming capital allowance therefore one is strongly advised to seek professional advice from an accountant to ensure compliance as well as to stay informed about changes in tax laws.