The capital allowances section of the self assessment tax return form is the most difficult for people who are self employed and not conversant with at least a minimum knowledge of accounting and the tax system. The difficulty in this section of the tax return form is that it is an area which many start up businesses may not have come across before. It is an area which affects not just the calculation of the tax allowances and knowledge of the tax rates but also how an item becomes considered for such tax allowances.
The first step towards claiming capital allowances is to understand that not all purchases which may have been entered into the accounts are treated the same for tax purposes. 100% of the purchase price of the majority of items is deducted from income to produce a net taxable profit. Purchases of certain items where that item is not consumed by the business in a single year but may be used by the business in both the current year and future years are not expensed in the year of purchase but classified as fixed assets.
A fixed asset includes not just the original cost of the item but also the cost of alterations, improvements and extensions of the asset. The fixed asset cost does not include the repairs and maintenance of that asset which may be treated as a normal business expense and written off against income when incurred. Accounting records need to be kept of fixed asset purchases in order for the capital allowances to be calculated and included in the self assessment tax return.
Having identified certain items as fixed assets the normal accounting practise is to use a technique called depreciation to write off the cost of the asset against profits over the expected life of that asset. The scale of the write off being a management decision as all depreciation calculations are ignored for tax purposes. Depreciation is entered on the self assessment tax return and subsequently deducted in an adjustment section.
When calculating the net taxable profit of a business the tax system add back to the profit shown in the business accounts any depreciation charges the business has made in the preparation of the accounts. The tax system then deducts the capital allowances from the net profit made by the business and shown on the self assessment tax return form to arrive at the actual net taxable profit, those tax allowances being according to a fixed set of rules applicable for the tax year.
Completing the self assessment tax return form also includes calculating the capital allowances which compromise of two elements. Capital allowances being a first year allowance which can be claimed on some types of fixed asset and writing down allowance on the net asset value in subsequent years until the total value of the fixed assets has been claimed against profits earned.
The rate of first year allowance for small businesses has changed each year from 2004-05 to 2007-08 starting in 2004-05 at 40%, rising to 50% the next year and then back to 40% in 2006-07 before returning to 50% in 2007-08. The first year allowance can be claimed on most assets except vehicles were special rules are applied.
Generally first year allowances can not be claimed on vehicles except if that vehicle is deemed to be a commercial vehicle. The inland revenue website contains a list of vehicles it considers to be vans and commercial vehicles and first year allowances can be claimed. Cars and commercial vehicles not on the approved list are not subject to a first year allowance except new vehicles with low CO2 emissions below 120gm per km driven.
The writing down allowance is 25% of the net written down value for tax purposes and is the amount of capital allowance claimed on fixed assets after the first year and in the case of motor vehicles used for business purposes in the first year. Capital allowances on motor vehicles being restricted to a maximum of 3,000 pounds per vehicle and vehicles costing over 12,000 pounds being in a separate section of the tax return to those under 12,000 pounds
The capital allowance section of the self assessment tax return form also includes the term balancing charges. A balancing charge arises when an asset is sold or disposed of and is the difference between the amount received and the net written down value for tax purposes. Net written down value is the original cost less capital allowances that have already been claimed against the net taxable profit.
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