You may have heard of capital allowances and that they can help businesses. But what is a capital allowance? Read to learn its meaning and benefits.
In most countries, including the US, governments offer tax write-offs for specific business assets. This is in a bid to promote investment, innovation, environmental consciousness, and employment. Capital allowance is the broad term for these tax reliefs.
A business is liable for these tax write-offs for the specific assets bought and retained by the company during the tax period. However, before the business can claim their capital allowance, they need to establish firmly which allowance they cannot claim.
Read on to find out the capital allowance meaning and why it’s so important for businesses large and small. That way, you can see how your business can benefit from these allowances and what assets qualify for capital allowances.
What Is Capital Allowance Meaning?
A good place to start would be answering the question, “what is a capital allowance?” Capital allowance is a tax write-off that businesses enjoy for procuring specific assets. Assets viable for capital allowance vary from country to country, but in the US, most assets apply to capital allowances.
Capital allowances only apply to assets procured during the tax period. They don’t apply for any assets already in possession of the business before the tax period. The business must also be using the said assets before they can qualify for capital allowances.
As stated earlier, only specific categories of assets can qualify for capital allowance. Furthermore, some of these assets may be eligible for partial capital allowance claims instead of complete claims.
The IRS calculates the value or a fraction of the value of these items. They then deduct this cost to the company’s taxable income.
Assets Viable for Capital Allowance
Before requesting capital allowance from the IRS, it is important to know what assets actually qualify for capital allowances. Here are categories of assets that qualify for this tax relief.
Plant and Machinery
This category includes any industrial machinery for the production process. They also include stuff like trucks, cars, vans, and any other vehicle. Some pieces of equipment also fall under this category.
Research and Development and Patents Cost
Any assets acquired by a business for research and development, especially if they actually patent a product.
Renovations to Business Premises
Renovations you make to your business establishments qualify for capital allowances. However, note that this doesn’t include any structures, roads, or bridges. These don’t count as business renovations.
These include leases on equipment, buildings, and gas and water systems. Also, you may qualify for capital allowance for entertainment costs, when you get entertainment systems, for instance.
Types of Capital Allowances
All capital allowances can be broadly classified into three categories. These are Annual Investment Allowance, writing down allowance, and first-year allowance.
Let’s look at each type in detail, starting with the annual investment allowance.
Annual Investment Allowance
In this capital allowance, businesses will deduct the full amount of some of the assets that qualify for capital allowance. The condition is that the assets in question must be in use by the business during the tax period.
Plenty of assets fall under AIA, but not all of them. Assets like cars and gifts cannot be included in your annual investment allowance.
Writing Down Allowance
Think of writing down allowances as compensation for missing your capital allowances of the past financial year. If you don’t claim your capital allowances, both AIA, or first-year allowance, the government will give you a claim for a percentage of the cost during the next financial year.
This claim is what is known as writing down allowance. Unlike both AIA and first-year allowance, the IRS doesn’t deduct this allowance at once. Instead, they spread the deductions over a few years.
The cost percentage will depend on the type of assets eligible for the capital allowances. For instance, cars with lower carbon emissions usually get higher deductions than less environmentally-friendly cars.
The IRS typically uses the cost at the time of purchase to calculate these deductions. However, for deductions on things like gifts or previously owned equipment, the IRS will use the current market value.
This type of capital allowance is only for select items. It advocates for the purchase and use of water-efficient, energy-efficient, and eco-friendly equipment.
Items that qualify for first-year allowances include zero-emission vehicles and solar energy equipment, to name a few. Typically, the business subtracts between 6% and 100% of the entire cost of the asset. You must buy the items in question within the financial year to qualify for capital allowance.
What Are the Benefits of Capital Allowances?
Capital allowances can be very beneficial to businesses and can save you a bundle at the end of each financial year. Here are some reasons why you should always have capital allowances on your radar.
Frees up Cash for Both Personal and Business Use
Lowering your tax bill, means you have more money that you can channel into the business. You can also use some of the surplus cash for your personal needs. Depending on the scale of your business and what assets you bought, you could save quite a significant amount of money.
Increases Your Likelihood of Getting a Tax Refund
Tax refunds come easily with capital allowances. Plus, in addition to tax refunds, you also lower the amount of tax you pay quite significantly. A tax reduction is just what you need to grow your company and wealth too.
Boosts the Economy and Protects the Environments
A lot of assets that qualify for capital allowances are environmentally friendly or water and energy-efficient. This gives companies the incentive to purchase such equipment, which helps protect the environment.
Capital allowances also allow businesses to re-invest in the economy, which helps boost the economy. So if you want to do the economy and environment a favor while saving some money, then the capital allowance is your answer.
Capital Allowance Is Good for Business
Now that you know the capital allowance meaning, it’s high time to be on the lookout for these capital allowances. That way, you can free up some cash flow and do the environment a favor while you’re at it. So next time you’re getting assets for your business, remember to get those that qualify for capital allowance.
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