If you make large purchases of equipment or machinery that you'll use over a long period of time, you may want to treat these as "capital purchases" or "fixed assets".
This lets you "depreciate" these assets over time, to smooth the purchase over the period that you'll be using it.
Capitalising assets: An example
Say you run a car rental business, and you buy a car for £15k, which you rent out for £7k per year for 3 years. After 3 years, you'd have made £6k in profit (3 x £7k - £15k).
If you depreciate your £15k asset over 3 years, then you'd have £5k of depreciation each year.
So each year, your profit would be £2k (£7k - £5k).
This is more reflective of how well the business is doing than showing a loss of £8k in year one, and a profit of £7k in years 2 & 3.
When is something an asset?
There's no exact rules about exactly what an asset is, it's up to you, but it's based on:
How long will you use the purchase for?
How big was the purchase?
Are purchases like this common?
Are they a significant part of your total outgoings?
Assets are large purchases that you will use over a long period of time.
Examples of Expenses:
Examples of Assets:
Laptops and computers
Cars and vehicles
Why is this useful?
There are 3 main benefits of capitalising assets like this:
Recording your assets so you can keep track of them
Smoothing the cost of big purchases, so you get a better sense of how much profit you're making
Reporting the figures to HMRC, in case there's a difference in tax you pay
What's the tax treatment?
Depreciation is not an allowable expense for tax purposes, and so if you're depreciating assets, you have to add this back to your profit before working out your tax.
However, there is relief you can claim on the asset purchase itself, called "capital allowances".
Is this the same for Sole Traders and Limited Companies?
HMRC tries to make things simpler for sole traders. They suggest using the "cash basis" approach where you just simply claim for what you spend within the year.
You can see this on this page on the Gov site.
So you don't need to worry about capital allowances if you choose to use the cash basis, available to sole traders with income under £150k.
What capital allowances are available?
When you capitalise a purchase as an asset, you can claim a "capital allowance", which is used to deduct part or all of the value of purchase from your taxable profit.
There are 3 main types of capital allowance:
Annual Investment Allowances
First Year Allowances
Writing Down Allowances
What's the Annual Investment Allowance?
For most freelancers, self-employed people and small business owners, purchases you make on most "Plant and Machinery" can be claimed against your "Annual Investment Allowance", or AIA.
"Plant and Machinery" includes:
items that you keep to use in your business
lorries, trucks and motorcycles
costs of demolishing plant and machinery
parts of a building considered integral, such as lifts, heating systems etc
some fixtures, eg fitted kitchens or bathroom suites
alterations to a building to install other plant and machinery - this doesn’t include repairs
(Note that the AIA can't be used against cars, which have different rules below)
The AIA allows you to deduct the full cost of an asset from your taxable profit in the year of purchase.
Each year, you can use the AIA on up to £200k or asset purchases (from 1 Jan 2016 - 31 Dec 2018). From 1 Jan 2019 the allowance is £1m for the next 2 years.
What are First Year Allowances?
Certain assets you can claim a First Year Allowance. The most likely case where this will apply to you is on low emission car purchases, but it also applies to other eco-friendly purchases.
If you can't claim the AIA or First Year Allowances on your purchases, then you're left with Writing Down Allowances.
What are Writing Down Allowances?
You can check out the Gov website for details of how these are worked out. You add each asset purchase to a "pool" of purchases, and each year you can claim up to 18% of the total amount in the pool, as well as reducing the pool by the same amount.
If you've used the AIA of First Year Allowances, then you won't have any assets left to be added to a pool, so you won't have any Writing Down Allowances.
Is my tax bill the same if I expense it?
If your purchase qualifies for the AIA or First Year Allowance, then the tax will work out the same as if you expense it rather than capitalise it.
If you treat a purchase of eg a laptop as an allowable expense, rather than capitalising it and using the AIA, then the impact on both cases is to reduce your taxable profit in the year by the cost of the item.
You'll reduce your tax bill by the same in both cases.
If you spend more than the AIA on asset purchases (over £1m in purchases from 1 Jan 2019), then you'll start to pay different amounts of tax.
Do I have to capitalise my assets?
It's not always the case that you need to capitalise assets.
For example, if you're a freelancer that buys a laptop, none of these 3 benefits will necessarily apply to you. Hopefully you'll remember you own a laptop, it's not going to impact your profitability from year to year significantly, and the tax you pay is the same either way.
How to use Coconut when you're purchasing assets
If you're are purchasing assets as a Coconut user, there are a few options:
Consider whether you really need to capitalise assets
If you make relatively few or modest asset purchases that qualify for the AIA then you could expense these instead. This simplifies your record keeping as you don't need to worry about fixed assets or depreciation. As noted above, your tax will work out the same.
Work it out at the year end
Mark any asset purchases as "Equipment" in Coconut, and then at the end of the year you can work out the entries required to prepare your annual accounts (most likely with the help of an accountant).
You can read more about capitalising assets and claiming capital allowances on the Gov website.