Capital allowances

Tax relief for small businesses has risen with the increase in the first-year capital allowance. Georgina Harris finds out how to take advantage
Businesses can claim a type of tax relief, known as capital allowances, against some business purchases and investments. In practice, claiming a capital allowance means that you set off a proportion of the costs of purchases against the profits you make and so reduce your tax bill. Most capital allowances allow you to write off a percentage of the value of the asset against profits over several years. The rate of the allowance depends on what you buy and when you bought it.

In April 2006, the first-year capital allowance for small businesses investing in plant and machinery increased from 40 per cent to 50 per cent. The extra ten per cent will only be available until March 2007, so it may make sense to make the most of your allowance now. Graham Morgan, partner and specialist SME adviser at chartered accountants Kingston Smith, explains how.

"Be aware of available allowances. For example, a lot of small firms don't realise that building refurbishment may qualify as plant and machinery spending. If you're planning to carry out costly work on your premises, get a tax analysis at an early stage and organise your works accordingly. Getting your accountant involved as early as the design stage could pay off."

You can also claim capital allowances on items that you only use in part for business purposes. The allowance is reduced by the amount of private use. For example, a computer used 70 per cent of the time for work purposes would be eligible for 70 per cent of the usual allowance. So you can now claim 50 per cent of the original cost of a computer in the first year (as a first-year capital allowance) if the computer is used solely for business purposes, and in the example of part-private use, the business can claim 70 per cent of that half. If your new computer cost £1,000, your business-only allowance will be £500, and after pro-rata sharing deductions you will get £350 of tax relief against your profits.

Morgan advises: "Let the business drive your spending - not the thought of the tax you'll save. Don't buy equipment you don't need."

He goes on to explain that careful timing of your purchase could also help. "As a rule of thumb, I advise my clients to make their investments towards the end of their annual accounting period, because this has tax advantages. But sole traders and partnerships should check this out, because the rules vary for them.

"It is also usually worth claiming your allowances even if your business is not in profit. Again, you should always get this checked by your accountant, particularly if you are a sole trader. But even if you don't claim, you can carry the allowances over to the following year."

Finally, remember that capital allowances carry on after the first year in which you made the purchase. You can claim 25 per cent a year on plant and machinery on a 'reducing-balance basis' in subsequent years, until the cost of the equipment is written off or the item is sold, disposed of, or given away.