What Is a Capital Allowance and How Can It Help Your Business During COVID-19?

It is impossible to know how badly COVID-19 will affect America’s economy. However, some projections estimate that the annualized drop in GDP may be as much as 37% for this quarter alone.

Such economic shrinkage is bad news for every business. If you’re a business owner, you may well be worried about what the future holds for you.

One possible tool that may help you is a capital allowance.

So, what is a capital allowance? Read on as we take a closer look at the concept and how it might benefit your business.

What Is a Capital Allowance?

A capital allowance is a form of tax relief that businesses can avail of in respect of certain assets and investments. The function of a capital allowance is to facilitate the writing-off of expenses incurred on an asset over a period of time.

To claim a capital allowance, you will have to have invested in a capital asset during the relevant tax period. This might be a piece of property, or a significant item of machinery or equipment.

In America, capital expenditure on research and development will also qualify.

The investment in question doesn’t necessarily have to be an outright purchase. For example, if you spent a significant sum on the renovation of a previously owned property, the cost of this renovation may qualify.

For an asset to qualify, it must be in regular use for the purposes of your business. Therefore, a property that you purchased as a speculative venture will not usually count.

However, if you were claiming rental income on the relevant property or asset during the tax period, this will qualify the asset for an allowance.

Non-durable assets cannot get you a capital allowance.

How Can You Claim a Capital Allowance?

To proceed with a capital allowance claim, you should first make an accurate assessment of the value of your investment.

This is particularly important where the cost involved is not clear-cut, such as in the case of a combination of investments or a number of different capital assets.

You will also have to calculate the extent of the depreciation on the asset. You will likely need the assistance of a valuation expert here.

If you think that a capital allowance could solve some of your financial problems during this crisis, look around to find more information. The process can be difficult to understand at first. The more research you do, the better-positioned you will be to take advantage of it.

Different Types of Capital Allowance

Capital allowances are available in respect of many different kinds of assets. However, allowances can be broken down into two broad types.

Annual Investment Allowance

This allowance permits you to deduct the full cost of a given asset from your tax bill, provided the asset is in use.

The upper limit for this type of relief in America is $1.27 million per year. You must avail of the deduction in the tax period in which the asset came into the possession of your business.

Not every asset can be used to claim this allowance. Cars are ineligible, as are assets that come to your business by way of a gift.

First Year Allowance

This allowance targets eco-friendly investment. The rates of reduction vary from 6-100% of the amount of the investment.

As with the annual investment allowance, the benefit must be claimed in the same tax year as the investment was made.

Eligible investments include carbon-neutral vehicles and clean energy solutions.

Writing Down Allowance

If you fail to claim a first-year allowance or annual investment allowance in the relevant year, you may avail of something called a writing down allowance.

This is a reduction spread out over several years. Available rates vary depending on your particular circumstances.

The Benefits of a Capital Allowance

There are numerous reasons why a capital allowance might benefit your business during this crisis.

Firstly, capital allowances give beneficiaries an immediate benefit in respect of assets. At a time when liquidity is one of the biggest issues facing businesses, this is hugely important.

As well as this, there are long-term benefits in terms of cost reduction. It’s always a good idea to lessen your tax burden as much as possible.

A distinct advantage of this type of tax relief is that it benefits high-earning businesses as well as small enterprises. The upper limits on allowances are high, meaning that you can avail of these benefits even as a larger operation.

Difficulties in Relation to Capital Allowances

Capital allowances are potentially lucrative. However, they are not without their challenges.

The main issue to be tackled is the complexity of the process. The IRS does not hand out tax deductions easily, so you will have to jump through many administrative hoops in order to secure an allowance.

There are also strict audits on these kinds of allowances. If a claimed allowance is found to be excessive, the business will be liable for repayment of the excess along with interest and penalties, which may be significant.

Because of these complications, many businesses end up understating their entitlements. This wastes money by leaving potential tax deductions unclaimed.

It is, therefore, a good idea to seek the counsel of a tax expert if you are considering availing of a capital allowance.

Using a Capital Allowance to Stay Afloat During COVID-19

So, what is a capital allowance? If you’re one of the many thousands of American businesses that are struggling to stay solvent during this crisis, it might just be the answer to your prayers.

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