What are Depreciation and Capital Allowances?

Depreciation & Capital Allowance

As I talk you through your accounts you will see depreciation in the statutory accounts for Companies House, but when it comes to the corporation tax computation for HMRC it is disallowed, why’s that?  

When a company purchases a fixed asset (ie machinery, computer equipment, furniture, vehicles etc) HMRC and Companies House will deal with it differently depending on the type of asset purchased.  

Depreciation is the accounting term that is used to spread the cost of a fixed asset over what is classed as its useful life, So for example a van costing £12,000 that will  be useful for 5 years – the cost of this will be spread over 5 years rather than deducting the the whole amount off the companies profits in one year.  

However, when it comes to HMRC they ignore the depreciation figures and give their version of it which is called capital allowances.  

With the exception of cars, or an asset that is partly used for private use, capital allowances for assets are usually calculated at 100% of the value of the asset in the  year of purchase (currently to a limit of £1m in the financial year). 

To give a working example:  

A van is purchased for the exclusive use of the company for £12,000 it has a useful life of 5 years.  

The company net profit is £24,000 which includes a deduction of £2,400 for depreciation.  

When the figures are extracted for the corporation tax return the depreciation is disallowed (added back on) – so now the trading profit is £26,400 – however 100% capital allowance is given for the van:  

£26,400 less £12,000 = profit chargeable to Corporation Tax of £14,400 Corporation Tax charge (currently19% for 21/22 tax year) = £2,736 

The accounts submitted to Companies House will show a profit after tax of £24,000 – £2,736 = £21,264 

If you are thinking of making a fixed asset purchase and are unsure of the best way,  please talk to us first, we can help with the most tax efficient way to make a purchase.  Just drop us an email to either your usual contact or hello@pinkpigfinancials.co.uk and we’ll be happy to help.  Or if you’re not already a client and would like to explore working with us pop over to our Work With Us page, complete the questionnaire and book a discovery call.