Capital allowances enable businesses to write off the cost of assets over time, thereby reducing taxable profits. Within this system, the concept of a “balancing allowance” arises when you dispose of an asset—whether by selling it, scrapping it, or otherwise ceasing to use it—and need to settle any remaining difference in your capital allowances calculation.
Understanding Capital Allowances
When you buy an asset for business use, its cost is often not fully deductible in the year of purchase. Instead, you claim a portion of its cost over multiple accounting periods. This process is governed by specific rates and schemes, such as the Main Pool, Special Rate Pool, and the Annual Investment Allowance. Over time, the value of the asset in the capital allowances system (commonly called the “tax written-down value“) decreases as you claim writing-down allowances.
Discrepancies between an asset’s tax written-down value and its disposal proceeds must be reconciled. Balancing figures adjust total allowances claimed to match the asset’s actual disposal value.
Balancing Allowance vs Balancing Charge
- Balancing Allowance: This occurs if the asset’s disposal proceeds or value is lower than its tax written-down value. Essentially, you have not claimed enough tax relief over the asset’s life, so you are entitled to a final allowance to compensate for this difference.
- Balancing Charge: If the disposal proceeds exceed the tax written-down value, you have effectively overclaimed capital allowances. In that scenario, the difference must be added back into your taxable profits through a balancing charge.
Balancing allowances and charges can apply to individual assets or entire “pools” of assets, depending on the capital allowances scheme in use. If a pool has multiple assets, you generally only perform a balancing calculation when the pool is closed—that is, when every asset in that pool is disposed of.
How to Calculate a Balancing Allowance
- Identify the Tax Written-Down Value: Sum up the amount of capital allowances already claimed on the asset or pool. Subtract that total from the original cost (or the cost after any first-year allowances), resulting in the asset’s current tax written-down value.
- Subtract Disposal Proceeds: Determine the value of the asset at disposal. If it has been sold, use the sale price. If it’s been scrapped, the disposal value could be zero.
- Calculate the Difference: If the disposal proceeds are less than the tax written-down value, the shortfall is the balancing allowance.
- Claim the Allowance: Include this figure as an allowable expense in your business’s tax computation for that year.
Example: Imagine you purchase a piece of machinery for £10,000. Over several years, you claim writing-down allowances totalling £8,000, leaving a tax written-down value of £2,000. Later, you sell the machine for £1,000. Because the proceeds (£1,000) are less than the tax written-down value (£2,000), you would receive a balancing allowance of £1,000. This ensures you gain full tax relief on the asset’s depreciation over its useful life.
A balancing allowance helps businesses claim the right capital allowances, preventing missed tax relief or paying too much in taxes. It looks at the difference between the asset’s remaining tax value and how much it sells for. Knowing how to calculate this allowance helps manage capital allowances effectively, lowers tax bills, and ensures compliance.
If you’re help with business tax, call our tax advisors or send us an email for further clarification.
