What is a capital purchase?

Ah, the excitement of buying new gear for your business! But when it comes to tax time, not all expenses are treated equally. Let’s talk about capital purchases and how they fit into your tax calculations.

What is a capital purchase?

A capital purchase, also known as a capital expenditure, is money spent by your business on acquiring, maintaining, or improving fixed assets. These are the big-ticket items that have a long-term use in your business, such as:

• Machinery and equipment

• Vehicles

• Buildings and renovations

• Computers and software

Think of capital purchases as investments in the infrastructure of your business—stuff that helps you operate and grow over multiple years.

Do capital purchases reduce my corporation tax bill?

Here’s the kicker: unlike regular business expenses, capital purchases aren’t fully deductible in the year you buy them. Instead, you claim the cost over several years through something called capital allowances.

What are capital allowances?

Capital allowances let you write off the cost of certain assets against your taxable profits. Instead of deducting the full amount in one go, you spread the deduction over the asset’s useful life. This is done through:

• Annual Investment Allowance (AIA): Allows you to deduct the full value of qualifying items (like machinery) up to a certain limit (£1,000,000 as of the current tax year, check here for updates) in the year of purchase. After hitting this limit, other rules apply.

• Writing Down Allowances (WDA): For assets that don’t qualify for the full AIA or exceed the limit, you can deduct a percentage of the remaining value each year. There are different rates for different types of assets (e.g., 18% for most machinery, 6% for special rate assets like integral features of buildings).

Capital allowance example

Let’s say you buy a piece of machinery for £50,000. Here’s a simplified example of how you might claim it:

• Year 1:

  If within the AIA limit, you can deduct the full £50,000.

• Beyond AIA Limit:

  If your purchases exceed the AIA limit, you might claim part under AIA and the rest through WDA. For instance, if the machinery exceeds the AIA limit, and you need to use WDA, you’d claim 18% of the remaining value each year.

Why it matters

Understanding this helps you plan your finances better. Large capital purchases can significantly impact your cash flow, so knowing you can’t deduct the entire amount immediately is crucial. It spreads the tax benefit over several years, aligning the expense with the period over which the asset generates income for your business.

Final thoughts

Capital purchases are essential for growing your business, but they come with specific tax implications. By grasping how capital allowances work, you can better manage your tax liabilities and make more informed financial decisions.