What is a capital asset in a small business?

What exactly is a capital asset, what makes it different from other assets and how does it fit into your business?

This guide will cover:

• What a capital asset is and how it works
• When an item becomes a capital asset
• How to record your capital assets
• What depreciation means
• What capital allowances are
• How to claim capital allowances

Capital assets (sometimes called fixed assets) are usually any piece of equipment you use in your business that is useful for more than a year. If you’re a freelance writer, that asset would be your laptop, desk and chair. If you’re a contractor, your capital assets would be your tools, van and other equipment you use on your jobs. 

These assets are called capital assets because you have to spend money on them as part of your business operations. Your capital is money you have available to run your business operations. Since you also need the assets for your daily operations, they become capital assets. However, capital assets are not part of your day-to-day costs like heating and power. They are also called ‘fixed’ assets as you’ll use them regularly over the long term.

There’s no set price limit at which an asset becomes a capital asset. However, to qualify as a capital asset, you must own the item mainly for its role in keeping your business alive. Some things that you use both for work and personal purposes may not qualify. For example, if you own a car that doubles as your private car and a company vehicle to visit clients. 

Whether an item qualifies as a capital asset also depends on the size of your company. For a one-person business, spending £600-£1,000 on a new laptop could be a significant enough transaction to be a capital asset. 

However, for a large company with several employees, this kind of cost would only be a regular running expense (regular business costs like rent, utility bills, etc.).

Since capital assets are useful long term, you record them on your balance sheet (also called a statement of financial position). The balance sheet provides a snapshot of your assets and liabilities to determine the business financial position. 

However, every year you’ll use up some of the asset’s value, meaning that if you try to sell it, you won’t get as much for it as you paid when you bought it. You’ll need to deduct a bit of the total value to allow for this loss. 

This is called ‘depreciation’ and you can work it out as a percentage of the total cost of your capital asset or as a percentage of the asset’s value at the start of the year. We’ll explain more about depreciation below.

Depreciation is an accounting method where you allocate the cost of a physical asset to match its useful life or life expectancy. In other words, depreciation describes how much of an asset’s value has been used up. 

You can depreciate long-term assets for both tax and accounting purposes, like taking a tax deduction for the cost of the asset to reduce your taxable income. As such, depreciating assets helps you earn revenue from an asset while claiming a portion of the cost off your taxes every year it’s in use. Not accounting for depreciation could throw off your profit calculations. 

As we mentioned, you can deduct a portion of your taxes for capital assets. Tax relief on capital assets is called capital allowance. 

A capital allowance is an expense you may claim against your company’s taxable profit. You can claim capital allowances on most assets bought for use in your business, such as equipment, research costs, building renovations and so on.

You can claim capital allowances on items you need to run your business, which HMRC refers to as ‘plant and machinery’. In most cases, companies may deduct the full cost of items from their profits before tax using something called annual investment allowance (AIA).

However, sole traders with an annual income below £150,000 may be able to use the simpler cash basis system instead. 

Plant and machinery includes:

• Items you keep to use in your business, including cars
• Parts of a building considered necessary, known as ‘integral features’
• Some fixtures, such as fitted kitchens or bathroom suites
• Building alterations to install other plant and machinery, not including repairs

You cannot claim capital allowances on:

• Items you lease (you must own them)
• Buildings, including doors, gates, shutters, mains water and gas systems
• Items used only for business entertainment, like a karaoke machine

When you’ve worked out your capital allowances, claim on your:

• Self Assessment tax return if you’re a sole trader
• Company Tax Return if you’re a limited company (you must include a separate capital allowances calculation)

You can find out more about claiming capital allowances on GOV.UK.

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