An introduction to capital allowances: key considerations for UK businesses

UK businesses cannot claim tax deductions for depreciation of their capital assets. They can however deduct capital allowances, and this article provides a brief introduction to capital allowances and some key issues to bear in mind when dealing with them.

What are capital allowances?

Most businesses will purchase assets for use in their business and offset this expenditure against their taxable trading profits, thereby reducing their tax liability. It is not possible, however, to do this for capital assets such as cars and machinery that have an ongoing benefit to a business but which depreciate over time. The depreciation on those assets is also not tax-deductible. Capital allowances were therefore introduced to provide a specific deduction to reflect the depreciation of capital assets for tax purposes, and businesses can claim these against certain capital expenditure to reduce their taxable trading profits.

When are capital allowances available?

Allowances are not given automatically, but both unincorporated and incorporated businesses can claim capital allowances in their tax returns. For allowances to be claimed, businesses must allocate expenditure on their capital assets to either a "main rate pool" or "special rate pool", depending on the nature of the asset. The balance on the pools is then written down by a set amount each year (either 18% or 6% respectively) and that allowance is deducted from a business’ taxable trading profits.

In addition to these writing down allowances, businesses also have access to a number of specific capital allowances that are designed to incentivise investment such as an "annual investment allowance" of up to £1 million of expenditure and full expensing allowances that allow for a deduction of either 100% or 50% of expenditure on new assets purchased. The availability and rate of both writing down allowances and any other allowances depends on the nature of the asset and in some cases the nature of the business entity; for example, full expensing is only available to companies and not to unincorporated businesses.

The most commonly available allowances are on expenditure on plant and machinery, but for each type of allowance only "qualifying" expenditure can be claimed. What is deemed "qualifying" depends on the nature of the allowance in question. By way of example, cars are generally eligible for writing down allowances but not for the annual investment allowance.

What are some key issues to bear in mind?

Businesses will of course need to give careful consideration to capital allowances on the acquisition of assets, and to whether, when and what allowances may be available. It is equally important to consider carefully how to treat assets on which capital allowances have previously been claimed when a business disposes of them. Some of the issues that business may need to be consider are:

1. Balancing charges: As a general rule, the disposal value of that item needs to be brought into account by the business who claimed allowances on it. If that value exceeds the allowances given, balancing charges can arise, increasing the business’ taxable profits.
2. Connected parties: Where disposals are made to connected parties, consideration needs to be given to whether it is advantageous to elect for the assets to be transferred at their written down value to avoid balancing adjustments.
3. Capital gains losses: As a general rule, claiming capital allowances should not affect the capital gains position on disposal of an asset. There are exceptions to this however, such as where assets are sold at a loss, where the capital allowances previously claimed can result in a restriction on any capital loss. The seller should therefore confirm that any disposal will not give rise to any unexpected capital gains outcomes.

Importantly, capital allowances can be a valuable and often overlooked issue on the sale of a commercial property. Part two of this article here, highlights some specific considerations when dealing with capital allowances in a commercial property context. 

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, January 2025