Following a single invoice through the system is the quickest way to understand capital allowances. The money leaves, the accounts treat it one way, the tax computation treats it another, and somewhere in between two decisions are made that determine how much tax the company saves and when.
The accounts and the computation part company
The invoice is capitalised in the accounts as a fixed asset and depreciated over the years the directors think it will last. The tax computation starts from the accounting profit and immediately adds that depreciation back, because tax law does not accept it. In its place the computation deducts capital allowances. The two systems are describing the same purchase and they will never agree in any single year, though over the asset's whole life the total relief is the same.
Decision one: which allowance
Most spending qualifies for the annual investment allowance, which relieves it in full up to £1 million. A company can also use full expensing, or leave the expenditure to be written down at 14% or 6%. A profitable company generally wants the relief now; a company making a loss may prefer to leave expenditure in the pool, because a loss relieved at nothing today is worth less than an allowance claimed in a year when the company pays the main rate.
Decision two: which pool
Whatever is not relieved in full goes into a pool, and which pool decides whether it is written down at 14% or at 6%. Integral features, long-life assets, thermal insulation and higher-emission cars go to the special rate pool; most other plant goes to the main pool. On a building this allocation is the whole job, because the electrical and cold water systems, the lifts and the air conditioning are integral features while the loose equipment in the same room is not.
Questions people ask about how do capital allowances work
How do capital allowances reduce tax?
They are deducted in computing taxable profit, in place of depreciation which is added back. Less taxable profit means less corporation tax, and because the rate bands turn on that figure a large claim can also move the company into a lower band.
Do I get the relief all at once?
Only if the expenditure qualifies for the annual investment allowance, full expensing or another first-year allowance and the company chooses to claim it. Otherwise relief comes through the pool at 14% or 6% a year on the reducing balance.
What if the company is making a loss?
It can claim less than the maximum and leave the expenditure in the pool for a more profitable year, which is often worth more than creating a larger loss now.