Connect with us

Accounting & Finance

What Is a Capital Allowance and Why Are They Important?

Last updated by


business accounting

As a business owner, you must have heard the term capital allowance. You have been wondering what it is and how you can enjoy it. Educate yourself on what a capital allowance is and why it’s so integral to so many businesses.

What Is Capital Allowance?

This is an expenditure that you can claim against your taxable profit. It is actually a tax relief that a business enjoys as a result of its capital expenditure.

In the U.S, the capital allowance applies to most assets that belong to the organization. These include equipment, expenses on the renovation of buildings, research costs, among others.

For these assets to qualify for the capital allowance, they must have come into the possession of the business in the course of the tax period. They must also have been in use by the business.

It is worth noting that not all assets qualify for these allowances. This is because, for them to qualify, they must fall in certain specific categories. For example, expenses on non-durable items cannot qualify for capital allowance.

There are certain assets whose full values can be claimed and there are others that can only enjoy partial claim. The categories also specify whether the full allowable amount is deductible in one year or not.

After the computation of the amount of capital allowance expenditure for a particular tax period, this figure should appear on the tax returns submitted to the tax department.

Acceptable Capital Allowances

The Internal Revenue Service regulates capital allowance in the U.S. It has the mandate to collect taxes, pay some state expenditure and administer of the regulatory regime including the minimum wage.

Capital Allowances laws in the U.S. allow capital allowances on a broad range of expenditures. Under the category of Plant and Machinery, we have assets such as cars and equipment, trucks and vans.

For these assets, the total value or a fraction of the value is deducted from the profits made by the company before the computation of the tax due.

Another category that enjoys capital allowance comprises of renovations to the premises, patents, and research and development costs. But structures and land, including docks, roads, and bridges are not part of capital allowance considerations.

Others include leased items such as gas and water systems, buildings plus their shutters, doors, and gates. Also included are and any item used for entertainment in the business such as an entertainment system or a boat.

Types of Capital Allowance

Capital Allowances fall into two categories, the annual investment allowance, and the first-year allowance.

The Annual Investment Allowance (AIA)

This is a type of capital allowance in which businesses deduct the full value of some assets provided the assets are used in the business.

The largest value for this deduction is $1.27 million per year. And the deduction must take effect in the financial year (taxation year) in which the asset came into the possession of the business.

Many assets fall under this arrangement except gifts, cars, among others. You might need to learn more about plant and machinery in capital allowance claims to enjoy the full benefits of this type of capital allowance.

First-Year Allowance

First Year Allowance is a capital allowance in which the business deducts between 6-to-100 percent of the cost of the assets. These assets must qualify for capital allowance.

It must take effect in the year that the item was purchased and it is an incentive for businesses to invest in eco-friendly and emerging products.

The items that fall in this category include equipment that is water or energy efficient. They include low carbon dioxide emission cars, zero-emission vehicles, and water-saving equipment.

Writing Down Allowance

If you fail to claim the annual investment allowance or the first-year allowance that you are entitled to, the government can still allow you to claim a percentage of the cost in the next financial year using writing down allowances.

This allowance is usually not deducted at once. It is spread out over several years. It can even apply to some items that are ineligible for the other allowance. These include gifts, cars, or items that were purchased and used before the business acquired them.

The fraction of the cost that can be deducted depends on the type of asset. For cars, this amount also depends on their level of carbon dioxide emissions. More efficient cars enjoy higher deductions.

The cost means the amount paid for purchasing the asset, but if the asset was previously owned or if it is a gift, then its market value is used in computing the allowance.

What Are the Rates for the Writing Down Allowance?

Many assets owned by businesses qualify for a deduction of 18 percent of their value per year. There are others that qualify for only 8 percent deduction. They include air conditioning, escalators and other features of buildings.

Also included are items with life spans of 25 years and above, cars with high carbon dioxide emissions, thermal insulation or structures, to name but a few.

Capital Allowance Will Help You to Save Money

As stated earlier, the capital allowance is deducted from profits before the calculation of the tax due. This is of great benefit to a business because it lowers its tax burden hence increasing its profitability.

Capital allowance is an incentive to businesses with the aim of boosting the economy. With investment in capital assets, businesses increase their production capacity. This also lowers the level of unemployment in a country.

Through Capital allowance, the government encourages businesses to invest in items that are friendly to the environment. This ensures that the amount of carbon dioxide emission into the atmosphere goes down.

Most of the companies now know the benefits of a capital allowance. That’s why they are very careful about what types of assets they invest in. They usually pick assets that they are sure will qualify for these deductions. If you want to know more about capital allowance and how your business can enjoy it, you can visit our blog.