While a potential difficult area for the non accountant capital allowances reduce the net tax payable. The difficulty in this section of the tax return form is that it is an area which many start up businesses may not have come across before. It is an area which affects not just the calculation of the tax allowances and knowledge of the tax rates but also how an item becomes considered for such tax allowances.

100% of the purchase price of the majority of items is deducted from income as business expenditure to produce a net taxable profit. Purchases of certain items where that item is not consumed by the business in a single year but may be used by the business in both the current year and future years are not expensed in the year of purchase but classified as fixed assets. It is these items which are not written off in the tax year but are subject to capital allowances.

A fixed asset includes not just the original cost of the item but also the cost of alterations, improvements and extensions of the asset. The fixed asset cost does not include the repairs and maintenance of that asset which may be treated as a normal business expense and written off against income when incurred. Accounting records need to be kept of fixed asset purchases in order for the capital allowances to be calculated and included in the self assessment tax return.

Having identified certain items as fixed assets the normal accounting practise is to use a technique called depreciation to write off the cost of the asset against profits over the expected life of that asset. The scale of the write off being a management decision as all depreciation calculations are ignored for tax purposes. Depreciation is entered on the self assessment tax return and subsequently deducted in an adjustment section.

When calculating the net taxable profit of a business the tax system add back to the profit shown in the business accounts any depreciation charges the business has made in the preparation of the accounts. The tax system then deducts the capital allowances from the net profit made by the business and shown on the self assessment tax return form to arrive at the actual net taxable profit, those tax allowances being according to a fixed set of rules applicable for the tax year.

Completing the self assessment tax return form also includes calculating the capital allowances which compromise of two elements. Capital allowances being a first year allowance which can be claimed on some types of fixed asset and writing down allowance on the net asset value in subsequent years until the total value of the fixed assets has been claimed against profits earned.

The rate of first year allowance for small businesses has changed each year from 2004-05 to 2007-08 starting in 2004-05 at 40%, rising to 50% the next year and then back to 40% in 2006-07 before returning to 50% in 2007-08. The first year allowance can be claimed on most assets except vehicles were special rules are applied.

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