12 Oct Capital Allowances Explained: The £1 Million Allowance Most Directors Underspend
The £1 million Annual Investment Allowance can give your business valuable tax relief, but only if you claim it correctly.
If you run a limited company or work as a sole trader, buying equipment, vehicles or other business assets can be a significant investment. Capital allowances are the rules that let you deduct some or all of that investment from your taxable profits.
Many small business owners assume capital allowances are only relevant to large companies. That is not the case. The Annual Investment Allowance (AIA) is currently set at £1 million, and it is available to most businesses, including limited companies and sole traders.
However, the rules are not always straightforward. Cars are treated differently from vans, the timing of a purchase matters, and some assets only receive partial relief in the first year.
Here is how the main rules work.
What are capital allowances?
Capital allowances provide tax relief on certain business assets that you use in your trade.
Normally, you cannot deduct the full cost of a long-term asset as an ordinary business expense. Instead, you claim capital allowances against your taxable profits.
Qualifying assets can include:
- Computers, laptops and office equipment
- Machinery and tools
- Commercial vehicles such as vans and lorries
- Fixtures and integral features, such as electrical systems or air conditioning
- Some energy-saving or environmentally focused equipment
The tax treatment depends on the type of asset, how your business is structured and when the expenditure is incurred.
You can read the current HMRC guidance on capital allowances for the technical rules. If you are preparing your year-end accounts, our annual accounts service can also help ensure relevant claims are not overlooked.
How does the £1 million Annual Investment Allowance work?
AIA allows most businesses to deduct 100% of qualifying plant and machinery costs, up to £1 million.
The AIA is a first-year allowance. This means you can usually deduct the full cost of qualifying assets from your taxable profits in the accounting period in which you buy them.
For example:
- Your company buys qualifying equipment costing £40,000.
- You claim AIA on the full £40,000.
- Your taxable profit is reduced by £40,000, subject to the normal rules.
The £1 million limit applies for a 12-month accounting period. If your accounting period is shorter, the limit is reduced proportionately. For example, a six-month accounting period would generally have an AIA limit of £500,000.
There are also special rules where companies are connected or controlled by the same person. In some circumstances, connected companies must share one AIA limit rather than receiving £1 million each.
AIA can be very useful, but you do not always have to claim the full amount. If claiming all the available relief would create an unnecessarily large loss, you may choose to claim only part of the cost and receive the balance through writing-down allowances later.
See HMRC’s Annual Investment Allowance guidance for more detail.
What is full expensing for limited companies?
Companies can potentially claim 100% full expensing on qualifying new and unused main-rate plant and machinery.
Full expensing is separate from AIA. It is available only to companies within the charge to Corporation Tax, not to sole traders or ordinary partnerships.
Generally, the asset must be:
- Plant or machinery that falls within the main rate
- New and unused
- Bought for the company’s business
- Owned by the company rather than bought for leasing to someone else
- Not a car
Where the rules are met, the company can deduct 100% of the qualifying cost from its taxable profits in the year the expenditure is incurred. Unlike AIA, full expensing does not have a £1 million cap.
Full expensing and the associated 50% first-year allowance for special-rate assets were made permanent for qualifying company expenditure. You can read the Government’s guidance on permanent full expensing.
What happens to special-rate assets?
Some assets fall into the special rate pool. Examples include:
- Integral electrical features
- Air conditioning and cooling systems
- Solar panels
- Thermal insulation
- Long-life assets
- Higher-emission cars
For qualifying companies, new and unused special-rate plant and machinery can generally receive a 50% first-year allowance. The remaining 50% is added to the special rate pool and receives writing-down allowances, normally at 6%.
This is a common area for missed claims. A business may identify the equipment but fail to claim the 50% first-year allowance, or fail to carry the balance into the correct special rate pool.
How do the rules differ for sole traders and limited companies?
Your business structure affects which first-year reliefs are available.
Sole traders
A sole trader cannot claim full expensing. However, a sole trader can usually claim:
- AIA of up to £1 million, subject to the accounting period and other conditions
- Writing-down allowances on qualifying costs not covered by AIA
- Certain specific first-year allowances where available
If you use an asset privately as well as for business, you must restrict the claim to the business-use proportion.
For example, if you buy a laptop for £1,200 and use it 75% for business and 25% privately, the capital allowance claim may need to be restricted to £900.
Limited companies
A limited company can potentially claim:
- AIA on qualifying plant and machinery
- Full expensing on qualifying new and unused main-rate assets
- The 50% first-year allowance on qualifying special-rate assets
- Writing-down allowances on amounts not covered by another relief
If the company provides an asset for your private use, the tax position may involve benefit-in-kind reporting or other considerations. Do not assume that putting a personal purchase through the company automatically creates a valid capital allowance claim.
Our bookkeeping service for small businesses can help keep business purchases properly recorded and separated from personal spending.
Why are cars excluded from AIA?
Cars are not treated like vans, even when they are used for business.
HMRC excludes business cars from:
- Annual Investment Allowance
- Full expensing
- The 50% special-rate first-year allowance
- Other specific first-year allowances, subject to limited exceptions
Instead, cars usually receive relief through writing-down allowances. The rate depends mainly on the car’s emissions and when it was bought.
For cars bought from April 2021, the broad treatment is:
- New and unused zero-emission cars: potentially 100% first-year allowance
- Cars with emissions of 50g/km or less: main-rate allowances
- Cars with emissions above 50g/km: special-rate allowances
From April 2026, the main writing-down allowance rate is generally 14%, while the special rate remains 6%.
Vans, lorries and trucks are different. They do not normally count as cars for capital allowance purposes, so a qualifying van may be eligible for AIA or full expensing, depending on your business structure and the other conditions.
Always check the vehicle’s classification rather than relying on its everyday description.
Why does the year-end matter?
A purchase made just after your year-end normally belongs to the next accounting period.
A common mistake is assuming that ordering an asset before the year-end is enough to secure the tax relief in that period. Usually, it is not.
Capital expenditure is generally treated as incurred when your obligation to pay becomes unconditional. For many ordinary purchases, this is linked to delivery, provided payment is due within four months.
So, if your company year-end is 31 March:
- Equipment delivered on 28 March, with payment due within four months, may fall into the year ending 31 March.
- Equipment ordered on 28 March but delivered on 4 April will normally fall into the next accounting period.
- Paying a deposit or signing an order may not be enough on its own.
The purchase date can affect:
- Which accounting period receives the claim
- Whether a first-year allowance is available
- Whether you have used your AIA limit
- Which writing-down allowance rate applies
Do not bring forward a purchase simply for tax relief. The asset should be commercially useful and affordable for your business. However, if you are already planning an investment, check the timing with your accountant before placing the order.
Worked example: a limited company investing £60,000
The type of asset determines how much relief you can claim immediately.
Imagine a limited company buys the following during its accounting period:
- New main-rate production equipment: £40,000
- New commercial van: £12,000
- Special-rate electrical installation: £8,000
Assume the company meets the relevant conditions and has enough available allowance.
The potential treatment could be:
- £40,000 equipment: 100% full expensing
- £12,000 van: 100% AIA or full expensing
- £8,000 special-rate installation: 50% first-year allowance, giving £4,000 immediately, with the remaining £4,000 entering the special rate pool
The first-year deduction could therefore be:
£40,000 + £12,000 + £4,000 = £56,000
The remaining £4,000 would generally receive writing-down allowances over later periods.
This is a simplified example. The actual claim depends on ownership, whether the assets are new or used, private use, connected companies, VAT treatment and the company’s accounting period.
What mistakes should you avoid?
A short review before your accounts are prepared can prevent valuable relief from being missed.
Check that you have not:
- Assumed a car qualifies for AIA because it is used for business
- Claimed full expensing as a sole trader
- Treated an order or deposit as the purchase date without checking when the obligation became unconditional
- Bought an asset immediately after year-end and expected the claim in the previous period
- Claimed the full cost of an asset used privately as a sole trader
- Missed the 50% special-rate first-year allowance
- Failed to carry the remaining special-rate balance into the correct pool
- Ignored connected-company rules
- Claimed two different allowances on the same expenditure
- Kept insufficient invoices, delivery records or finance documents
Capital allowances can look intimidating, but you do not need to work through every pool and exception alone. As a limited company accountant or small business accountant, Harrison’s Accountancy can review planned purchases, explain the available options and include the correct claims in your accounts or tax return.
If you are a sole trader, our self-assessment accountant service can help you report capital allowances accurately. We also support businesses across Bedfordshire, Hertfordshire, London and throughout the UK, including clients working in the media and entertainment sector through our media accountant service.
The rules can change and this article is general guidance for UK businesses, not personal tax advice. Speak to your accountant before making a significant investment or submitting a claim.
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