What Are Capital Allowances?
Capital allowances are the way HMRC gives you tax relief when your business buys something that lasts. Equipment, machinery, computers, vans, tools, office furniture, fixtures in a building. You cannot simply deduct the cost of those things as an expense the way you deduct rent or wages. Instead you claim a capital allowance, which reduces your taxable profit by a set amount.
That is the whole idea. Money spent on running the business comes off your profit straight away. Money spent on assets the business will keep and use comes off through the capital allowances system instead, sometimes all in one year and sometimes spread over many.
The rules live in the Capital Allowances Act 2001 and they apply whether you trade as a sole trader, a partnership or a limited company. What differs is which allowances you are allowed to use, and that difference matters more from 2026 than it has in years.
Why Your Depreciation Figure Does Not Reduce Your Tax Bill
This is the point that catches out almost every business owner the first time they see their tax computation.
In your accounts, you spread the cost of an asset over its useful life using depreciation. A £12,000 machine you expect to use for six years might be depreciated at £2,000 a year. That is proper accounting and it gives a fair view of your profit.
HMRC ignores it completely. Every penny of depreciation in your accounts is added back when your taxable profit is worked out, and capital allowances are given instead. The reason is consistency. Depreciation policy is a judgement call, so two identical businesses could report very different profits simply by choosing different useful lives. HMRC replaces that judgement with a fixed set of rules that everyone has to follow.
So you end up with two parallel figures for the same asset. The accounting figure, which shows up as a fixed asset on your balance sheet at net book value. And the tax figure, which sits in a capital allowances pool. They rarely match, and they are not supposed to.
What Qualifies, and What Does Not
Most capital allowances are claimed under the heading of plant and machinery, which is a much broader category than the words suggest. It covers:
- Tools, machinery and equipment
- Computers, servers, tablets and phones
- Office furniture, shelving and fittings
- Vans, lorries and most commercial vehicles
- Cars, though under their own restricted rules
- Integral features of a building, meaning lifts, escalators, electrical systems, heating and air conditioning, water systems and external solar shading
- Fixtures such as fitted kitchens, bathroom suites, CCTV and alarm systems
- Thermal insulation added to an existing building
Some things are outside the plant and machinery rules entirely:
- Land never qualifies, which is also why land does not depreciate in your accounts.
- The structure of a building does not qualify for plant and machinery allowances. Instead there is a separate Structures and Buildings Allowance at 3 percent a year on a straight line basis, which takes just over 33 years to give full relief.
- Anything leased rather than bought generally belongs to the lessor, so the person who owns it claims the allowances, not the person using it.
- Intangible assets such as software licences bought outright can qualify, but purchased goodwill and most other intangibles go through the separate corporate intangibles regime and are relieved in line with amortisation rather than capital allowances.
- Trading stock is not a capital item at all. It goes through cost of sales.
One practical note. Claim on the cost excluding recoverable VAT if you are VAT registered, because you get that VAT back separately. If you are not VAT registered, or the VAT is blocked as it is on most cars, the VAT inclusive figure is your cost for capital allowances.
The Annual Investment Allowance: £1 Million at 100 Percent
The Annual Investment Allowance, almost always shortened to AIA, is the allowance that matters to most businesses and the one that makes everything else academic for the vast majority of them.
The AIA gives 100 percent relief in the year of purchase on qualifying plant and machinery, up to £1 million of spending per accounting period. It is available to sole traders, partnerships and companies alike. Spend £40,000 on equipment and the full £40,000 comes off your taxable profit this year.
Two things to watch. First, the £1 million limit is pro rated for short accounting periods, so a nine month period gets £750,000. Second, cars never qualify for AIA, no matter how clearly they are used for business.
For context on scale: a business would need to spend more than £1 million on equipment in a single year before the AIA runs out. That is why, in our experience, the great majority of small and medium businesses can claim every penny of their equipment spending in the year they spend it and never think about pools, rates or first year allowances at all.
Full Expensing and the 50 Percent Special Rate Allowance
Full expensing gives 100 percent relief with no upper limit on new and unused main rate plant and machinery. There is no £1 million cap, so a company spending £4 million on qualifying equipment can relieve the whole £4 million in year one.
Alongside it sits a 50 percent first year allowance on new special rate assets, meaning integral features, long life assets and thermal insulation. You claim 50 percent in year one and the remaining half goes into the special rate pool.
Both come with an important restriction. They are available to companies only. Sole traders and partnerships cannot use them, which for years left unincorporated businesses spending over £1 million with nothing better than a slow writing down allowance on the excess. That gap is exactly what the new 40 percent allowance is designed to close.
Both also require the asset to be new and unused. Second hand equipment is out, and so are cars.
The New 40 Percent First Year Allowance from January 2026
This is the significant change, and it is worth understanding properly because most guides written before the Autumn Budget on 26 November 2025 do not mention it at all.
For expenditure incurred on or after 1 January 2026, there is a new permanent 40 percent first year allowance on main rate plant and machinery. You deduct 40 percent of the cost in the year of purchase, and the remaining 60 percent goes into the main pool to be relieved through writing down allowances in later years.
What makes it notable is who can use it and what it covers:
- It is available to companies and unincorporated businesses, so sole traders and partnerships finally have an accelerated allowance beyond the AIA.
- It covers assets bought for leasing, other than overseas leasing, which previous first year allowances excluded. Hire and plant rental businesses are the clearest winners here.
- It does not cover cars, second hand assets, or assets for overseas leasing.
Be clear about what the 40 percent allowance actually is, though. It is not a giveaway. It is an acceleration. You are pulling relief forward, not creating extra relief, and the balance still crawls through the pool afterwards.
Writing Down Allowances and the Pools, Now at 14 Percent
Whatever you cannot cover with the AIA or a first year allowance goes into a pool and is relieved through writing down allowances, or WDAs. This is where the second big 2026 change lands.
| Pool | What goes in it | WDA rate |
|---|---|---|
| Main pool | Most plant, machinery, equipment, computers, vans, cars up to 50g/km CO2 | 14 percent from April 2026, previously 18 percent |
| Special rate pool | Integral features, long life assets, solar panels, thermal insulation, cars above 50g/km CO2 | 6 percent |
| Single asset pools | Short life assets you elect to keep separate, and assets with private use | Rate of the relevant pool |
The main pool rate falls from 18 percent to 14 percent from 1 April 2026 for companies and 6 April 2026 for sole traders and partnerships. The special rate pool stays at 6 percent.
Two mechanical points that matter in practice.
Pools are cumulative, not per asset. You do not track each machine separately. Additions go in, disposal proceeds come out, and the WDA is applied to whatever balance remains. A pool is a rolling balance that never quite empties, which is why WDAs are described as a reducing balance calculation.
The small pools allowance lets you write off the entire balance of the main or special rate pool if it has fallen to £1,000 or less, rather than grinding it down by 14 or 6 percent a year forever. It applies to each pool separately, so you cannot add the two together to reach the threshold.
Straddling the change date
If your accounting period spans the change date, you use a blended rate worked out proportionally. A company with a 31 December 2026 year end has three months at 18 percent and nine months at 14 percent, so the rate for that period is 15 percent. A 30 September 2026 year end gets six months of each, giving 16 percent. Expect this to catch out anyone running the calculation from memory in the first year.
What the rate cut costs you
The 4 percentage point cut sounds small. Over the first few years it is not. Take a main pool balance of £100,000 carried forward:
| Year | At 18 percent | At 14 percent |
|---|---|---|
| 1 | £18,000 | £14,000 |
| 2 | £14,760 | £12,040 |
| 3 | £12,103 | £10,354 |
| Three year total | £44,863 | £36,394 |
That is roughly £8,500 less relief over three years on a £100,000 pool. For a company paying the 25 percent main rate of corporation tax, that is around £2,100 of tax paid earlier than it would have been. The relief is not lost, it is deferred, but cash paid three years sooner is still cash out of the business.
A Worked Example
Take a sole trader plumbing business with an accounting year to 5 April 2027, buying:
- A van for £24,000
- Tools and test equipment for £6,000
- A laptop and office setup for £2,000
Total qualifying spend is £32,000, comfortably inside the £1 million AIA. So the full £32,000 comes off taxable profit in that year. With profits in the basic rate band, the marginal saving is 20 percent Income Tax plus 6 percent Class 4 National Insurance, so roughly £8,320 of tax and NI saved and claimed through the Self Assessment tax return.
Now change one thing. The plumber also buys a car with CO2 emissions of 90g/km for £20,000. That car cannot use the AIA and cannot use the 40 percent allowance. It goes into the special rate pool at 6 percent, giving £1,200 of relief in year one on £20,000 of spending. It takes more than a decade before even half the cost has been relieved.
Same business, same year, same money leaving the bank account. The tax treatment of the van and the tools is nothing like the treatment of the car. That single contrast explains most of the frustration business owners feel about this part of the tax system.
For a larger unincorporated business, the new allowance changes the picture. A partnership spending £1.5 million on new main rate plant in 2026/27 claims £1 million of AIA, then 40 percent of the remaining £500,000, which is £200,000, then 14 percent on the £300,000 balance going into the pool, which is £42,000. Year one relief is £1,242,000. Under the old rules with no 40 percent allowance and an 18 percent WDA, it would have been £1,090,000. The new allowance is worth about £152,000 of extra relief in year one to a business in that position.
Cars, Vans and Electric Vehicles
Cars have their own regime and it trips people up constantly.
- Vans, lorries and most commercial vehicles are not cars for these rules. They are ordinary plant and machinery, so they qualify for AIA and the 40 percent allowance.
- New and unused zero emission cars get a 100 percent first year allowance, currently available until 31 March 2027 for companies and 5 April 2027 for income tax. Electric vehicle charge points get the same treatment.
- Cars up to 50g/km CO2 go in the main pool at 14 percent.
- Cars above 50g/km CO2 go in the special rate pool at 6 percent.
- Cars never qualify for AIA, whatever their emissions.
- For a sole trader with private use of a car, it goes into a single asset pool and the allowance is restricted to the business proportion.
The gap between a 100 percent allowance on an electric car and a 6 percent allowance on a petrol one is one of the sharpest tax incentives in the system. Combine it with the low benefit in kind rate on electric company cars and the case for going electric through a business is a genuinely strong one, which is a point we return to when talking about directors' remuneration packages.
What Changed in 2026, and Who It Actually Affects
Pulling the two changes together: the main pool WDA fell from 18 to 14 percent, and a new permanent 40 percent first year allowance arrived for main rate spending.
Those two moves point in opposite directions, and that is deliberate. The Treasury expects the combination to raise roughly £1 billion in 2026/27 and around £1.5 billion a year after that, so on aggregate this is a tax rise dressed as an incentive. What it does is shift relief towards businesses that keep investing and away from businesses sitting on an existing pool.
In practice there are three groups who need to pay attention:
- Businesses spending more than £1 million a year on equipment. Everything above the AIA is now in play, and the choice between a first year allowance and the pool is a real decision.
- Leasing and hire businesses. For the first time they have access to an accelerated allowance on assets bought for hire out. This is the biggest single winner from the change.
- Sole traders and partnerships with heavy capital spending. They cannot use full expensing, so the 40 percent allowance is genuinely new ground for them.
Everyone else, meaning most businesses we act for, will spend under £1 million a year, claim the AIA in full, and never touch a pool except for cars. If that is you, the headlines about 2026 changes are largely noise.
Our View
Three honest observations after years of preparing these claims.
Claiming the maximum is not always the right answer. Capital allowances are not automatic. You have to claim them, and you are allowed to claim less than the maximum, leaving the balance in the pool for future years. That flexibility is worth more than it looks. A sole trader whose profits are already close to the personal allowance can waste relief by claiming a full AIA, because allowances that reduce profit below £12,570 save no Income Tax at all. Push profits too low and you can also drop below the Small Profits Threshold and lose a qualifying year towards your State Pension, which is a poor trade for a deduction you could have taken next year instead. For companies the same logic applies differently: profits between £50,000 and £250,000 are effectively taxed at 26.5 percent because of marginal relief, so an allowance used in that band is worth more than the same allowance used against profits taxed at 19 percent. Our corporation tax calculator will show you which band you are in.
Full expensing has a sting on disposal that AIA does not. When a company sells an asset on which it claimed full expensing, there is an immediate balancing charge equal to 100 percent of the sale proceeds, added straight to taxable profit. The 50 percent special rate allowance works the same way at half the proceeds. An asset that went through the AIA instead has its disposal proceeds deducted from the pool, which usually just reduces future writing down allowances rather than creating an immediate charge. So for a company with AIA still available that expects to sell the asset in a few years, AIA can be the better claim even though both give 100 percent relief up front. That is not a distinction we often see made, and it is worth checking before a large purchase.
Timing around a year end is the highest value conversation in this whole area. An asset bought the day before your year end gets full relief a year earlier than the same asset bought the day after, and the difference is pure cash flow. The reverse is also true. If profits are low this year and expected to be much higher next year, deferring a purchase can be worth real money. This is the sort of thing that costs nothing to get right and is impossible to fix retrospectively, which is why we would rather hear about a planned purchase in advance than see the invoice in a bookkeeping file six months later.
The broader picture, in our view, is that the UK capital allowances system has become more generous at the top and slower at the bottom. If you invest continuously you do well. If you bought heavily a few years ago and are now working down a pool, the 14 percent rate quietly costs you. Neither of those is obvious from a headline, which is rather the point of how these things are announced.
How IAK Can Help
We prepare capital allowances claims as part of every set of accounts we produce, for sole traders and limited companies across North London. That means keeping a proper fixed asset register through our bookkeeping work, making the right claim in the year end accounts, and taking a view on whether the maximum claim is actually the best claim for your position.
Where it gets more valuable is before the money is spent. Our tax planning work looks at planned equipment, vehicle and fit out spending against your year end, your profit forecast and your tax band, so the relief lands where it is worth most. For property fit outs in particular, splitting a single builder's invoice properly between the structure, integral features and plant is often worth thousands, and it is one of the most commonly missed claims we come across. If you have spent money on assets in the last few years and are not confident it was all claimed, contact us for a free consultation and we will take a look. You may also want to read our guide to what an accountant actually does and whether the choice between sole trader and limited company changes what you can claim.
Sources
- Claim capital allowances: Overview, GOV.UK, on what capital allowances are and what you can claim on.
- Claim capital allowances: Annual investment allowance, GOV.UK, on the £1 million limit, pro rating and the exclusion of cars.
- Work out capital allowances: rates and pools, GOV.UK, on the 14 percent main pool rate from April 2026, the 6 percent special rate, integral features and single asset pools.
- Capital allowances: permanent full expensing, GOV.UK, on the 100 percent and 50 percent first year allowances and the immediate balancing charges on disposal.
- Capital allowances: writing down allowances rate reduction and new first year allowance, Deloitte Taxscape, on the Autumn Budget 2025 measures and their effective dates.
- Budget 2025: what are the main changes to capital allowances?, PKF Francis Clark, on the blended writing down allowance rates for straddling accounting periods.
- HMRC Capital Allowances Manual at CA20000, GOV.UK, on the detailed plant and machinery rules.