Capital Allowances for Micro Entities Explained | UK Tax Rules

Capital allowances for micro entities allow your company to deduct the cost of qualifying business assets, such as equipment, machinery, and vehicles from your taxable profits, which directly reduces the amount of Corporation Tax you pay. If your micro entity buys a new laptop, tools, or a company vehicle, you do not simply write off that cost as a normal expense. Instead, you claim it through the capital allowances system. Most micro entities will benefit most from the Annual Investment Allowance, which lets you deduct the full cost of most qualifying assets in the year you buy them, up to a £1 million annual limit. This guide explains exactly how capital allowances work, which assets qualify, which do not, and how the system applies specifically to small limited companies filing under FRS 105.

What are Capital Allowances and How Do They Work for a Micro Entity?

Capital allowances are the UK tax system's way of giving businesses tax relief on the purchase of physical assets used in the business. Under normal accounting rules, the cost of an asset is spread over its useful life through depreciation. However, HMRC does not accept accounting depreciation as a tax deduction. Instead, it has its own system — capital allowances — which determines how and when the cost of an asset can be deducted from your taxable profits. This matters for micro entities because it means two things:

• The depreciation charge shown in your accounts is added back when calculating your Corporation Tax liability
• The capital allowances you are entitled to claim are then deducted instead, and the figures are often different from the depreciation you have charged in your accounts

In practice, many micro entities end up claiming more tax relief in the first year than their depreciation charge would suggest — especially when using the Annual Investment Allowance — because AIA allows 100% of the cost to be deducted in year one, regardless of how long the asset will be used.

What is the Difference Between an Asset and an Expense for Tax Purposes?

An expense is something that is used up in the course of running the business — printer paper, software subscriptions, phone bills, and accountancy fees are all examples. These are deducted from profit in the period they arise, with no capital allowance calculation needed. An asset is something with a longer useful life that the business will use over several years — machinery, vehicles, office furniture, and IT equipment are the most common examples for micro entities. The cost of these items cannot simply be written off as an expense in one go under standard tax rules; instead, they go through the capital allowances system. The distinction is not always immediately obvious, and HMRC's guidance draws the line based on whether the expenditure creates an enduring benefit for the business. If it does, it is likely to be capital expenditure, and the capital allowances rules apply.

What are the Different Types of Capital Allowances Available to Micro Entities?

There are several types of capital allowances available under UK tax law. Micro entities will primarily encounter the first three, but it is worth understanding all of them.

Annual Investment Allowance (AIA)

The Annual Investment Allowance is the most important capital allowance for the vast majority of micro entities. It allows you to deduct 100% of the cost of most qualifying plant and machinery in the year you buy it, up to an annual limit of £1 million (as of the 2024/25 tax year). For a micro entity with a turnover of under £632,000, the £1 million AIA limit is almost always more than enough to cover all qualifying capital expenditure in a given year. This means most micro entities will be able to claim full tax relief on everything they buy in the year of purchase, rather than spreading the relief over several years. The AIA applies to plant and machinery, which covers a wide range of items including computers, office furniture, tools, machinery, and most fixtures in commercial property. It does not apply to cars (which have their own rules) or to assets you acquire through a hire purchase or lease arrangement in certain circumstances.

Writing Down Allowance (WDA)

The Writing Down Allowance applies to assets that are not fully covered by the AIA, or to assets that fall outside AIA eligibility. Rather than deducting the full cost in year one, you deduct a percentage of the remaining value each year. There are two rates:

• Main rate pool — 18% per year. This covers most plant and machinery that is not in the special rate pool.
• Special rate pool — 6% per year. This applies to integral features in buildings (such as electrical systems, heating systems, and lifts), long-life assets, and thermal insulation.

In practice, most micro entities will prefer to use the AIA to claim 100% relief upfront on qualifying assets rather than taking the slower WDA route. However, WDA becomes relevant for assets that do not qualify for AIA (such as cars with CO2 emissions above the threshold) or where AIA has already been used in full for that year.

First Year Allowances (FYA)

First Year Allowances allow 100% of the cost of certain qualifying assets to be deducted in the year of purchase — similar to AIA, but applying to a specific list of assets regardless of whether AIA has already been used up. The most relevant FYA for micro entities at present is the allowance for zero-emission cars. If a micro entity purchases a new electric vehicle for business use, 100% of the cost can be deducted in year one under the First Year Allowance, outside of and in addition to the AIA limit. There have also been temporary first-year allowances introduced and extended at various points — such as the Full Expensing allowance introduced in April 2023, which allows companies to deduct 100% of qualifying main rate plant and machinery and 50% of special rate expenditure in the first year. This applies to incorporated businesses, including micro entities that are limited companies.

Structures and Buildings Allowance (SBA)

The Structures and Buildings Allowance provides relief for the cost of constructing, converting, or renovating non-residential buildings and structures used for business purposes. The relief is given at a flat rate of 3% per year on a straight-line basis. For most micro entities, the SBA is unlikely to be relevant unless the business owns or is improving a commercial property. The relief is available to the business that incurred the expenditure, and importantly, it is linked to the building rather than the business, so it can be claimed by future owners if the property is sold. Here is a quick reference summary of the main capital allowance types:

Type of Capital Allowance	Rate / Limit
Annual Investment Allowance (AIA)	100% up to £1 million per year
Writing Down Allowance — Main Pool	18% per year (reducing balance)
Writing Down Allowance — Special Rate Pool	6% per year (reducing balance)
First Year Allowance — Zero-emission cars	100% in year one
Full Expensing (limited companies only)	100% main rate / 50% special rate in year one
Structures and Buildings Allowance	3% per year (straight line)

Which Assets Qualify for Capital Allowances in a Micro Entity?

The term used in UK tax law for the main category of qualifying assets is 'plant and machinery'. Despite the name, this goes well beyond factory equipment. For most micro entities, the qualifying assets you are most likely to encounter include:

• Computers, laptops, tablets, and monitors
• Office furniture — desks, chairs, storage units
• Business phones and communication equipment
• Tools and specialist equipment relevant to your trade
• Commercial vehicles — vans, lorries, and other non-car vehicles
• Cars used for business purposes (subject to separate rules based on CO2 emissions)
• Machinery and manufacturing equipment
• Point of sale systems, till equipment, and payment terminals
• Security systems and CCTV equipment
• Solar panels and other energy-generating equipment installed for business use

The key requirement is that the asset must be used wholly or partly for business purposes. If an asset has mixed business and personal use — which is common for cars and phones — the allowance is restricted to the business-use proportion.

Do Fixtures and Fittings Qualify for Capital Allowances?

Yes, but the rules are more detailed for fixtures within buildings. Fixtures are items that are permanently attached to a building — fitted kitchen units in a commercial property, air conditioning units, electrical wiring, and sanitary fittings are all examples. Fixtures in commercial properties can qualify for capital allowances as plant and machinery, but the specific treatment depends on whether the fixture is an 'integral feature' (which goes into the special rate pool at 6% WDA) or a standard fixture (which goes into the main pool at 18% WDA or qualifies for AIA). For most micro entities that rent rather than own their premises, this is unlikely to be a significant issue. However, if your micro entity owns or has undertaken significant improvements to commercial property, specialist advice is worth seeking.

What Assets are Not Eligible for Capital Allowances?

Knowing what does not qualify for capital allowances is just as important as knowing what does. Claiming allowances on ineligible assets — or missing the fact that certain assets have restrictions — are both common mistakes in small company tax returns.

Land

Land never qualifies for capital allowances. You cannot depreciate land for tax purposes because it does not wear out or reduce in value in the way that a physical asset does. The purchase price of land is excluded from any capital allowances claim, even where buildings or structures on the land do qualify under the Structures and Buildings Allowance.

Residential Property

Capital allowances on plant and machinery cannot be claimed in a residential dwelling. If your micro entity owns a residential property, any assets within it — even those used for business purposes — are generally excluded from capital allowances claims. This is a common point of confusion for micro entities that operate partly from a home office; the position is different for sole traders compared to limited companies, but neither can claim capital allowances on the residential structure itself.

Non-Business Assets

Assets that are not used in the business at all do not qualify. If an asset is purchased by the company but used exclusively for personal purposes by a director, there is no capital allowances entitlement — though there may be other tax considerations, such as a benefit in kind charge.

Assets With a Short Useful Life

Some expenditure on items with a very short expected life — typically under two years — may be treated as revenue expenditure rather than capital expenditure, and deducted as a normal business expense rather than through the capital allowances system. This can actually be more beneficial, as there is no need to track the asset in the capital allowances pool.

Certain Leased Assets

If a micro entity leases an asset under an operating lease (as opposed to a hire purchase or finance lease), the capital allowances on that asset generally belong to the leasing company, not to the micro entity. The lease payments themselves are deductible as a business expense, but no capital allowances claim can be made by the lessee on the asset itself.

Financial Assets and Investments

Shares, bonds, and other financial instruments do not qualify for capital allowances. These are investments rather than business assets, and their tax treatment falls under different rules entirely.

Are There Capital Allowances on Intangible Assets?

This is one of the most frequently misunderstood areas of business taxation for small company owners. The short answer is: capital allowances under the plant and machinery rules do not apply to intangible assets. However, there is a separate relief system for intangible assets — the Corporate Intangibles Research and Development (CIRD) rules — which provides relief in a similar way.

What Is an Intangible Asset?

An intangible asset is something the business owns that has value but no physical form. Common examples include:

• Goodwill — the value attributed to a business's reputation, customer relationships, and brand beyond its physical assets
• Intellectual property — patents, trademarks, copyrights, and designs
• Licences and franchise agreements
• Software — though this has some specific rules discussed below
• Customer lists and databases

For incorporated businesses — including micro entities that operate as limited companies — intangible fixed assets are governed by the Corporate Intangibles regime rather than the capital allowances rules.

What About Goodwill in a Micro Entity?

Goodwill is a particularly important consideration for micro entities that have been acquired or that acquired a business. Since April 2019, the tax treatment of goodwill (and certain other customer-related intangibles) acquired on a business purchase has been eligible for relief under the Corporate Intangibles rules, with a fixed rate deduction of 6.5% per year. Prior to April 2019, there was a period during which goodwill acquired on a business acquisition was not eligible for relief at all. If your micro entity acquired goodwill during that period (broadly, between July 2015 and April 2019), the position may be complex — professional advice is recommended.

How Does a Micro Entity Actually Claim Capital Allowances?

Capital allowances are claimed through your Corporation Tax return (CT600) and the supplementary capital allowances pages. The process involves:

1. Identifying all capital expenditure incurred during the accounting period — every asset purchased that meets the qualifying criteria
2. Deciding which allowance to apply — AIA for most qualifying plant and machinery, WDA for non-AIA assets or assets already exceeding the AIA limit, FYA for qualifying assets such as zero-emission cars
3. Calculating the allowances claimed — the full cost under AIA, or the relevant percentage of the pool balance under WDA
4. Recording any disposals — if you sold or scrapped an asset during the period, the proceeds reduce the pool balance or trigger a balancing charge if the proceeds exceed the pool value
5. Including the capital allowances figures in the Corporation Tax computation — the allowances reduce your taxable profits, and Corporation Tax is then calculated on the reduced figure

For micro entities using an accountant, this process is handled as part of the annual Corporation Tax return preparation. For those who file their own returns, it is worth being thorough at the asset identification stage — missed assets mean missed relief.

Do You Need to Keep Records of Capital Expenditure?

Yes. HMRC requires businesses to retain records supporting any capital allowances claims for a minimum of six years. This means keeping:

• Purchase invoices for every qualifying asset
• Evidence of payment
• Details of business use where the asset has mixed business and personal use
• Records of disposal proceeds when an asset is sold or scrapped

For micro entities, the simplest approach is to have a dedicated folder — physical or digital — for capital expenditure receipts, separate from your general business expense receipts. This makes the accountant's job significantly easier at year-end and ensures the records are available if HMRC ever asks for them.

FAQs: Capital Allowance for Micro Entities

 

Can a Sole Trader Claim Capital Allowances as Well as a Limited Company?

Yes. Capital allowances are not exclusive to limited companies. Sole traders can claim them through their Self Assessment tax return in the same way that micro entity limited companies claim them through the Corporation Tax return. The same types of allowances — AIA, WDA, FYA, and SBA — are available, with the same rates and limits. The key difference is that sole traders report the relief through income tax rather than Corporation Tax, but the underlying calculations work the same way.

What Happens to Capital Allowances When a Micro Entity Closes?

When a company ceases to trade and is wound up, any remaining balance in the capital allowances pool gives rise to a terminal loss — a balancing allowance — which can be deducted in the final accounting period. If the pool balance is nil or has been exhausted by disposal proceeds, no further relief is available. Where disposal proceeds exceed the remaining pool balance, a balancing charge arises, which is added back to taxable profits in the final period. Proper planning at the point of dissolution can ensure these balancing allowances are captured correctly.

Can Capital Allowances Create a Loss?

Yes. If your capital allowances exceed your taxable profits in a given accounting period, the result is a tax loss. For micro entities, this loss can typically be carried back one year to offset the previous year's Corporation Tax liability (generating a repayment) or carried forward indefinitely to offset future profits. Capital allowances-driven losses can be a useful tax planning tool in years with high capital expenditure — another reason why the timing of asset purchases relative to your accounting year-end can be worth thinking about.

Does the Annual Investment Allowance Reset Each Year?

Yes. The Annual Investment Allowance is an annual limit — currently £1 million per year — that resets at the start of each accounting period. Any unused AIA from one year cannot be carried forward to the next. For most micro entities, the £1 million limit is far more than the capital expenditure in a given year, so this is rarely a practical constraint. However, where a business plans to make significant capital purchases, timing them within the same accounting period to maximise AIA use can be worth considering.

Is There Capital Allowances Relief on Electric Company Cars?

Yes — and the relief is particularly generous. New zero-emission cars (electric vehicles) purchased by a limited company qualify for a 100% First Year Allowance, meaning the entire purchase price can be deducted from taxable profits in the year of purchase. This applies regardless of whether AIA has already been used up. Cars with CO2 emissions between 1g/km and 50g/km qualify for the 18% main rate WDA, and those above 50g/km go into the special rate pool at 6% WDA. The combination of low or zero CO2 emissions vehicles and the generous First Year Allowance makes electric vehicles one of the most tax-efficient capital purchases a micro entity can make.

The Bottom Line

Capital allowances are one of the most valuable — and most consistently underused — tax reliefs available to micro entities. Used correctly, they can significantly reduce your Corporation Tax bill in the year you make capital purchases, rather than spreading the relief slowly over several years through depreciation. The system is more straightforward than it might initially appear. For most micro entities, the vast majority of qualifying purchases will be fully covered by the Annual Investment Allowance, meaning 100% relief in year one. The complications arise when dealing with cars (which have their own rules), intangible assets (which sit outside the capital allowances system), and the interaction with VAT (where the base cost for AIA depends on whether input VAT has been reclaimed). At Micro Entity Accounts, we handle the full Corporation Tax return for small limited companies — including the capital allowances computation — as part of our standard annual accounts service. If you are not sure whether you have been claiming everything you are entitled to, or if you want to make sure your next set of accounts captures all available reliefs correctly, we are happy to review your position and make sure nothing is being missed.