When a business buys equipment, machinery, or certain other assets, it usually can’t simply deduct the full cost as a normal expense in one go. Instead, most of these purchases fall under capital allowances — a system that lets you deduct some or all of the cost from your taxable profit, spread out according to specific rules. Understanding how this works can make a real difference to what you actually pay in tax.
What counts as a capital asset
Broadly, capital allowances apply to items you buy to keep and use in the business, rather than things you buy to resell or that get used up quickly. Common examples include:
- Machinery and equipment
- Business vehicles
- Computers and office equipment
- Certain fixtures in a building (like heating systems or fitted kitchens in a commercial property)
Everyday running costs — stock, stationery, rent, utility bills — are treated differently, as normal deductible expenses in the year they’re incurred, not through capital allowances.
The Annual Investment Allowance (AIA)
For most businesses, the main route is the Annual Investment Allowance. It allows you to deduct the full cost of qualifying equipment from your profits in the same year you buy it, up to an annual limit of £1 million. This is usually the simplest and most valuable option for smaller and mid-sized purchases, since it brings forward tax relief rather than spreading it over several years.
There are exclusions — cars don’t qualify for the AIA, for instance — and the £1 million limit, while unchanged since 2019, is set by the government and can be revised, so it’s worth checking the current threshold before relying on it for a specific purchase.
Sole trader example: A sole trader buys £8,000 of workshop equipment in one tax year and claims the full amount under the AIA, reducing that year’s taxable profit by £8,000.
Limited company example: A company spends £40,000 refitting its production line with new machinery and claims the AIA on the full amount, significantly reducing its corporation tax bill for that accounting period.
Full expensing for limited companies
For limited companies, there’s a further relief worth knowing about alongside the AIA: full expensing. Introduced in 2023 and made a permanent feature of the tax system, it allows companies to deduct 100% of the cost of qualifying new (not second-hand) plant and machinery from profits in the year of purchase — with no upper limit on the amount. This makes it the natural next step once a purchase exceeds the AIA threshold, or where a business wants to keep its AIA allocation free for other assets.
Full expensing isn’t available to sole traders or partnerships — it applies to companies within the charge to Corporation Tax only — and, unlike the AIA, it only covers new assets bought outright or via qualifying finance arrangements, not second-hand equipment. Cars are excluded, in the same way as under the AIA.
Limited company example: A company buys £150,000 of new manufacturing machinery, well above its AIA allocation for the year. Because the equipment is new and the business is a limited company, it can claim full expensing on the entire amount rather than splitting the claim between the AIA and writing down allowances.
The 40% First Year Allowance
Since 1 January 2026, a new 40% first year allowance has extended fast tax relief to some of the businesses full expensing left out. Unlike full expensing, it’s available to unincorporated businesses too — sole traders and partnerships — as well as to companies that couldn’t previously claim full expensing, such as leasing and hire businesses. It covers new (not second-hand) plant and machinery, excluding cars and assets leased overseas, and lets you deduct 40% of the cost in the year of purchase, with the remainder going into the normal writing down allowance pools in later years.
Partnership example: A partnership that’s already used its £1 million AIA allocation for the year buys a further £30,000 of new equipment. Under the 40% first year allowance, it deducts 40% of the cost — £12,000 — from its profits straight away. The remaining £18,000 then goes into the main pool, where it continues to attract writing down allowances at the standard 14% rate in future years, rather than the whole £30,000 sitting in the pool at that slower rate from day one.
Leasing company example: A leasing company buys £100,000 of new equipment to hire out to customers — a category that doesn’t qualify for full expensing. Under the 40% first year allowance, it deducts 40% of the cost — £40,000 — from its profits in the year of purchase. The remaining £60,000 is added to the main pool and written down at the standard 14% rate in subsequent years, rather than the full £100,000 having to work through the pool from scratch.
Writing down allowances
For assets that don’t qualify for the AIA, or once the AIA limit has been used up, you claim relief more gradually through writing down allowances. Instead of deducting the full cost in one year, you deduct a percentage of the remaining value each year, on a reducing balance basis — similar in concept to depreciation, though the rates are set separately for tax purposes. The main rate is currently 14% a year, cut from 18% with effect from 1 April 2026 for Corporation Tax and 6 April 2026 for Income Tax.
Different types of asset are grouped into different “pools” with different rates. The special rate pool — covering items like integral building features, thermal insulation, and higher-emission cars — is written down more slowly, at 6% a year. Cars, in particular, are usually dealt with this way rather than through the AIA, with the exact pool depending on the vehicle’s CO2 emissions.
Sole trader example: A sole trader buys a car for business use for £20,000. Since cars are excluded from the AIA, they claim writing down allowances instead — as a higher-emission car it falls into the special rate pool at 6% a year, giving a deduction of £1,200 in the first year, with the allowance continuing on the reduced balance after that.
Limited company example: A company that has already used its full £1 million AIA allocation for the year puts a further £10,000 piece of equipment into the main pool. It claims writing down allowances at 14% a year — £1,400 in the first year — on the reducing balance in subsequent years.
Structures and Buildings Allowance
Separate rules apply to certain construction and renovation costs on non-residential buildings, under the Structures and Buildings Allowance (SBA). This lets you claim relief on the cost of building or improving commercial premises at a flat 3% a year (over 33⅓ years), though it’s a distinct allowance from those covering plant and machinery, with its own conditions.
The limited company vs sole trader difference
Capital allowances themselves work the same way regardless of business structure — the underlying rules on the AIA, writing down allowances, and asset pools don’t change based on whether you’re a sole trader or a limited company. What differs is where the relief lands:
- Sole traders deduct capital allowances from their business profits before calculating Income Tax and Class 4 National Insurance through Self Assessment. The relief effectively reduces the trader’s own personal tax liability.
- Limited companies deduct capital allowances from profits before calculating Corporation Tax. The relief reduces the company’s tax bill, not the director’s personal one — though lower company profits can, in turn, affect decisions around dividends or salary.
This means the practical value of a capital allowance claim depends on the applicable tax rate for the structure in question, which is one of several factors that can influence the sole trader versus limited company decision as a business grows.
Keeping it manageable
Capital allowances can get detailed quickly, particularly when a business has a mix of assets bought in different years, some through outright purchase and some through hire purchase or finance. Keeping clear records of what was bought, when, and how it was paid for makes it far easier to claim accurately — and it’s an area where getting advice from an accountant, particularly around timing large purchases, often pays for itself.