In a separate article, we looked at First Year Allowance (FYA) that typically involves allowing taxpayers to write off a percentage of the expenditure of providing a capital asset in the year it was acquired. Writing Down Allowance (WDA) is different in that you can claim up to a set percentage of the balance (such as 20%) to be claimed as capital allowance each year. The allowance is calculated on the written-down value, i.e. original cost minus all the capital allowances claimed in past years.

The above practice is clearly evident in the case of single assets. In the case of these assets, when the asset is disposed off, the disposal value is compared with the written down value and a “balancing adjustment” is made. If the disposal value is higher, the excess capital allowance claimed in past years is added back in current year as “balancing charge.” If the disposal value is lower than the written down value, the difference in value is allowed to be claimed in that year as “balancing allowance.”

The scenario becomes somewhat complex when more than one asset is “pooled” for capital allowance purposes. Pooling involves adding expenditure on new assets to the pool total and deducting disposal proceeds from the total. If disposal proceeds exceed the expenditure in the pool, the excess is added to income as balancing charge.

Balancing allowances are not allowed in the case of pooling until the qualifying activity ends. At that time, any remaining qualifying expenditure in the pool is allowed as a balancing allowance.

Certain assets are required to be accounted separately for capital allowance purposes. These are single asset pools, and either a balancing charge or balancing allowance can arise when the asset is disposed off. Assets to be maintained as single asset pools include:

• Cars above the cost threshold where the expenditure was incurred before 1 April 2009 (where the taxpayer is within the charge to corporation tax) or 6 April 2009 (where the taxpayer is within the charge to income tax) CA23500;
• Short life assets CA23600;
• Ships CA25000;
• Assets used partly for other purposes CA27000;

There can be more than one multi-asset pools and the long-life asset pool is of particular significance for property businesses. We will look at the issue in a separate article.

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Capital allowance is the deduction available to UK tax payers while computing taxable income. In UK, depreciation is not an allowable expense and its place is taken by capital allowance.

Both depreciation and capital allowance become applicable when you buy long-term assets for business purposes. Buildings, plant & machinery and furniture are examples of such long-term assets. As these assets will be used over a number of years, you cannot write their costs off as expense in the year of purchase.

Instead, the typical solution is to estimate their useful life in years, and write off a proportionate amount each year over this life time. This is what we call depreciation. In UK, however, depreciation is not allowed as a business expense.

The capital allowance system also essentially allows you to write off the cost of assets over a number of years. However, the regulations regarding capital allowance is much more complex.

For example, in the case of buildings, the entire cost of the building cannot be the basis for claiming capital allowance. Instead, you have to segregate the cost into First Fix and Second Fix costs. Capital allowance can be claimed only for the Second Fix costs.

First Fix costs include costs up to and including plastering. Second Fix costs are all the costs after the plastering stage to final finishing. These actually include innumerable items such air-conditioning, electrical fittings (but not the wiring), water supply fittings (but not the piping) and so on.

Considering that you pay for the building as a whole, computing the Second Fix costs is a complex exercise requiring special valuation expertise. The result is that many businesses do not claim the capital allowances that they are entitled to, and pay significantly higher amounts of tax than they need to.

Accountants are not typically equipped to identify and value the borderline items eligible for capital allowances.

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