Running a small business in the UK comes with a host of responsibilities, and one of the most important is understanding the available tax relief options.
Capital allowances are a valuable but often misunderstood form of tax relief that can help reduce the amount of tax your business has to pay.
In this article, we’ll break down what capital allowances are, how they work, and ways small businesses can maximise this benefit.
What Are Capital Allowances?
Capital allowances are a type of tax relief that lets businesses deduct some or all of the cost of certain assets used in their operations from their profits, thereby reducing the tax they owe.
Put simply, it’s the tax system’s way of allowing businesses to spread the cost of their assets over time.
Typically, when a business buys a significant asset like machinery or computers, rather than expensing the total cost right away, the asset’s value is spread out (or depreciated) over its useful life.
But in tax terms, businesses can use capital allowances as a way to standardise these deductions.
Let’s break this down with a simple example:
Example: Suppose your business purchases a laptop for £1,000. Instead of treating that entire £1,000 as an expense in the year of purchase, you would record the laptop as an asset on your balance sheet and gradually depreciate it over its expected five-year lifespan. Through capital allowances, you can claim a set portion of the laptop’s cost each year, which reduces your taxable profits. This way, all businesses can benefit equally, regardless of their specific depreciation policies.
The Different Types of Capital Allowances
The capital allowances system involves more than just depreciating assets.
There are several types of allowances available, each designed to support different types of assets and align with current government priorities.
Let’s explore the main allowances small businesses should know about.
1. Annual Investment Allowance (AIA)
The Annual Investment Allowance (AIA) is one of the most advantageous types of capital allowances for small businesses.
It enables you to deduct the full cost of qualifying assets (up to a set threshold) from your profits in the year of purchase.
This provides an immediate deduction, rather than spreading the cost over several years.
The AIA was introduced in 2008, with thresholds that have varied over time. Initially set at £50,000, it has fluctuated over the years, reaching a maximum of £1 million.
For most small businesses, the AIA threshold will comfortably cover typical asset purchases like laptops, office furniture, and equipment.
Example: If you purchase a printer for your office at a cost of £2,000, you can deduct the full £2,000 from your taxable profits in the year you bought it.
Important Note: Cars are NOT eligible for the AIA. If you’re purchasing a company vehicle, you’ll need to consider other capital allowance options.
2. First-Year Allowances (FYA)
First-Year Allowances (FYA) are another valuable type of capital allowance, allowing businesses to deduct 100% of the cost of qualifying assets in the year they’re acquired.
Unlike the broader AIA, FYAs apply only to specific assets that the government prioritises.
Currently, FYAs are focused on environmentally-friendly or energy-efficient assets, supporting the government’s initiative to promote greener business practices. Some qualifying assets include:
- Electric vehicles
- Electric vehicle charging stations
- Solar panels
By claiming FYAs, your business can immediately deduct the cost of these eco-friendly assets, lowering your tax bill and supporting sustainability goals.
3. Full Expensing and 50% First-Year Allowance (FYA)
Some recent enhancements, such as Full Expensing and 50% FYA, have been introduced to provide even greater tax relief, in some cases allowing businesses to deduct more than 100% of an asset’s cost.
These measures can vary with government budgets, so it’s wise to keep informed about new allowances or consult a tax advisor.
Top tip: While you can’t claim both AIA and FYA on the same assets, if you’ve maximised your AIA for the year, you may still claim FYAs for qualifying assets to benefit from additional relief.
4. Writing Down Allowances (WDA)
If your assets don’t qualify for AIA or FYA, or if you’ve exceeded your AIA threshold, Writing Down Allowances (WDA) offer another option.
WDAs let you spread an asset’s cost over multiple years by deducting a percentage of the asset’s value from your taxable profits annually. This gradually reduces your tax bill over time.
How Capital Allowances Work In Practice
Let’s walk through a real-world example to see how capital allowances apply to your business’s tax bill.
Example: A Marketing Agency’s Asset Purchases
Imagine you run a small marketing agency, and in 2024 you buy the following assets:
- Laptop: £1,200
- Office furniture: £3,000
- Electric car: £25,000
Here’s how capital allowances can reduce your taxable profits:
Step 1: Calculate Your AIA
Both the laptop and office furniture qualify for the Annual Investment Allowance (AIA), meaning you can deduct their full cost from your profits for that year.
| Asset | Cost | Allowance Claimed | Deduction Applied |
| Laptop | £1,200 | 100% | £1,200 |
| Office furniture | £3,000 | 100% | £3,000 |
| Total AIA Claimed | £4,200 |
Step 2: Apply the First-Year Allowance
Your electric car qualifies for the First-Year Allowance (FYA) because it’s a low-emission vehicle. Therefore, you can deduct the full £25,000 from your profits for the year.
Step 3: Adjust Your Taxable Profit
Now, let’s adjust your taxable profit:
| Profit Before Deductions | AIA Deduction | FYA Deduction | Taxable Profit After Deductions |
| £80,000 | £4,200 | £25,000 | £50,800 |
Your capital allowances have reduced your taxable profits from £80,000 to £50,800, lowering your overall tax bill.
Key Considerations For Small Businesses
While capital allowances are a valuable tool for reducing your tax bill, there are a few things to keep in mind:
1. Plan Your Purchases
Carefully consider when to make large asset purchases.
Buying assets before the end of your financial year can help you claim capital allowances sooner, reducing your current year’s tax bill.
Conversely, buying assets after the year-end will affect the following year’s tax return.
2. Keep Accurate Records
If you use an asset partly for business and partly for personal use (e.g., a car), you can only claim capital allowances on the business portion of the asset.
Keep detailed records of how the asset is used to avoid any complications with HMRC.
3. Seek Professional Advice
Capital allowances can get complex, especially if your business is investing in a variety of assets or exceeding the AIA threshold.
It’s always wise to seek professional advice to ensure you’re claiming all the relief you’re entitled to while staying compliant with HMRC regulations.
Capital allowances can significantly reduce the tax burden on small businesses, making them an essential tool for managing cash flow and funding growth.
Understanding the different types of allowances available—from the Annual Investment Allowance to First-Year Allowances—can help you make informed decisions about asset purchases and maximize your tax savings.
While capital allowances may seem complicated at first glance, applying them strategically can bring real benefits to your business.
By staying informed and seeking professional advice when necessary, you can make the most of this valuable tax relief system.
