Capital allowances are a form of corporation tax or income tax relief for some, but not all, capital expenditure. A business will reduce, or write down, the value of many of its capital assets in its accounts year by year using a process known as depreciation or amortisation. Accounts depreciation is not tax-deductible. In its tax return, the business will replace depreciation with capital allowances, which can be used to reduce taxable profits.
Tax relief is not generally given in full at the time the expenditure is incurred, but is spread over a number of years. Different types of expenditure attract allowances at different rates.
If capital allowances are not available, the only tax relief for capital expenditure is a deduction in computing any capital gain on a subsequent sale of the relevant asset. Even this may not be a benefit if the sale results in a capital loss, as a capital loss can only be set off against a capital gain and cannot be used to reduce taxable income.
Capital allowances are optional and must be specifically claimed. If allowances are not claimed they are carried forward and can be used in a future period.
Not all assets qualify for allowances; for instance, expenditure on land does not generally qualify. The most common type of allowance is that on plant and machinery.
What type of expenditure qualifies for plant and machinery allowances?In order to qualify for plant and machinery allowances, expenditure must be:
In addition, the person incurring the expenditure must own the plant and machinery as a result of incurring it.
- on plant and machinery, and
- wholly or partly for the purposes of a qualifying activity
Capital expenditureThe rules on whether expenditure is capital, rather than revenue, are found in case law. The cases concentrate on factors such as:
- whether the expenditure is on a repair or an improvement
- whether there is an enduring benefit for the trade, and
- if an asset is replaced, whether the replacement is of the whole or only a part of that asset
Meaning of plant and machinery
Capital allowances are given both for plant and for machinery. Machinery does not have a special definition for capital allowances purposes, whereas there is extensive case law on the meaning of plant.
Plant can mean any apparatus with an element of durability that is used for carrying on a business. This is limited by statute to exclude assets that are part of a building or form a structure, although there is a long list of assets (including many that qualify as fixtures, for which see more below) that may still be plant despite being part of a building or structure.
There is an additional case law exclusion from the definition of plant for assets that form part of the premises in which the business is carried on.
Integral featuresIntegral features are a special category of plant and machinery. They are defined by statute and include electrical systems, cold water systems, space and water heating systems, air conditioning systems, and lifts.
Integral features represent an exception to the general rule that the definition of plant comes from case law. Statute specifically provides that integral features always qualify as plant).
Qualifying activitiesThe list of qualifying activities for capital allowances purposes includes:
- a trade
- a property business (UK or overseas)
- a profession or vocation
- certain types of leasing
- managing the investments of a company with investment business, and
- an employment or office
Fixtures are plant or machinery that is installed or fixed so that it becomes, in law, part of a building or land. Examples include boilers, alarm systems and fitted kitchen units. There are special rules to determine whether a taxpayer is eligible to claim allowances for expenditure on a fixture.
In order to claim allowances, the taxpayer must have an interest in the land or building of which the fixture is part. Further rules determine who may claim allowances where more than one person might have a claim, for instance where a person constructs a building, installs fixtures, then leases the building to another person for a capital sum that includes a payment for those fixtures.