Is Depreciation Tax Deductible

Depreciation is a standard accounting concept used to spread the cost of a fixed asset over its useful life. If you buy equipment, vehicles, tools or furniture for your business, their value usually declines over time. This reduction in value is known as depreciation and is recorded in your accounts as an expense. But does that mean depreciation is tax deductible?

In the UK, depreciation is not tax deductible. Although it is an allowable cost in your financial accounts, it is not recognised as a deductible expense for tax purposes. Instead, businesses must claim tax relief on capital expenditure using the capital allowances system, which is governed by separate rules set out by HMRC.

This article explains why depreciation is not deductible, how capital allowances work, and what business owners need to do to claim relief correctly on assets they purchase.

What Is Depreciation?

Depreciation is an accounting method used to reflect how an asset loses value over time. Rather than writing off the full cost of an asset in the year of purchase, businesses spread the cost across several years, matching the asset’s use with the income it helps to generate.

There are various ways to calculate depreciation, including:

• Straight line: Equal amounts over the asset’s life

• Reducing balance: Higher deductions in earlier years

• Units of production: Based on usage or output

In your profit and loss account, depreciation appears as an expense, reducing accounting profit. However, this is purely an accounting figure. HMRC does not accept depreciation as a legitimate deduction when calculating taxable profits.

Why Is Depreciation Not Tax Deductible?

HMRC does not allow depreciation as a tax-deductible expense because:

• It is subjective and based on accounting estimates

• Different businesses may apply different rates for similar assets

• It does not reflect actual cash expenditure in the year

To ensure consistency and fairness, HMRC requires businesses to use a standardised system called capital allowances to claim tax relief on qualifying capital expenditure.

When preparing your tax computation, you must add back depreciation to your accounting profit before applying any capital allowance claims.

For example:

• Net profit (after depreciation): £20,000

• Add back depreciation: £5,000

• Adjusted profit: £25,000

• Less capital allowances claimed: £5,000

• Taxable profit: £20,000

The capital allowance replaces the depreciation figure for tax purposes.

What Are Capital Allowances?

Capital allowances are a tax mechanism that lets businesses deduct the cost of certain assets from their taxable profits. They are available to both sole traders and limited companies, although the rules differ slightly for each.

Capital allowances apply to:

• Equipment and machinery

• Tools and computers

• Vans and business vehicles

• Office furniture and fittings

• Certain building fixtures (e.g. air conditioning, lifts)

You claim capital allowances on your tax return instead of deducting depreciation.

The main types of capital allowance include:

1. Annual Investment Allowance (AIA)
This allows you to deduct the full cost of qualifying assets in the year you buy them, up to the annual limit (currently £1 million). Most equipment and machinery qualifies for AIA.

2. Writing Down Allowance (WDA)
If your asset is not eligible for AIA or you exceed the AIA limit, you can claim a percentage of the asset’s value each year instead. The main rates are:

• 18% for main pool items

• 6% for special rate items (e.g. integral building features, long-life assets)

3. Full Expensing (companies only)
Introduced for qualifying companies from April 2023, this allows a 100% deduction for main rate expenditure with no annual limit. It applies to new (not second-hand) assets only.

4. First-Year Allowances (FYA)
These are enhanced allowances for certain energy-efficient or environmentally beneficial assets, usually at 100%.

Each of these options gives tax relief on the cost of fixed assets, but none involve recording depreciation in the tax return. You can claim one or a combination, depending on eligibility.

Depreciation in Company Accounts

Limited companies must produce accounts in accordance with UK accounting standards. These accounts include depreciation to show a realistic picture of asset value and profit.

Even though depreciation appears in the accounts:

• It is ignored for Corporation Tax

• It must be added back in the tax computation

• Tax relief is given separately through capital allowance claims

You still need to keep depreciation records for internal use, financial statements and audit purposes. But from HMRC’s perspective, they are not relevant for tax calculations.

Sole Traders and Partnerships

If you are a sole trader or in a partnership, you cannot claim depreciation in your Self Assessment return. Instead, you must:

• Use the simplified capital allowance method

• Apply the AIA or WDA to your asset purchases

• Keep a record of when and how much you spent

You may also use simplified expenses if you operate a small business, especially for vehicle costs. In this case, instead of capital allowances, you claim a flat rate per mile, which removes the need to track depreciation or calculate asset write-downs.

Vehicles and Depreciation

Business vehicles are a common source of confusion. You cannot claim depreciation on a car, van or lorry used for business. You must use capital allowances, which vary based on:

• The type of vehicle

• Its CO₂ emissions

• Whether it is new or second-hand

• Whether it qualifies for full expensing (companies only)

For example:

• Electric cars may qualify for 100% first-year allowances

• High-emission cars may go into the special rate pool (6%)

• Vans and commercial vehicles usually qualify for AIA or full expensing

Keep clear records and consider using professional software or an accountant to manage these claims correctly.

Disposal of Assets and Balancing Adjustments

When you sell or scrap an asset, you may need to make a balancing adjustment:

• If the sale proceeds are more than the remaining capital allowances balance, you may have to pay tax on a balancing charge

• If they are less, you may be entitled to a balancing allowance

This system ensures that you do not over- or under-claim tax relief over the life of the asset, even though depreciation itself was never claimed.

How to Claim Capital Allowances

To claim capital allowances, include the details on:

• Your Self Assessment tax return (for sole traders and partnerships)

• Your Corporation Tax computation (for limited companies)

You must:

• Identify qualifying expenditure

• Choose the correct allowance type (AIA, WDA, FYA or full expensing)

• Keep records of purchase dates, amounts and asset types

• Retain invoices and receipts for evidence

You do not need to submit depreciation schedules to HMRC, but you should maintain them for business records.

Conclusion

Depreciation is not tax deductible in the UK. While it is useful for accounting and reporting purposes, it is replaced by the capital allowances system when it comes to claiming tax relief. Whether you are self employed or run a limited company, you must calculate and claim capital allowances correctly to reduce your taxable profits.

Understanding the difference between depreciation and capital allowances ensures your accounts are compliant, your tax returns are accurate and you are claiming all available reliefs. If in doubt, speak to a tax adviser or accountant to ensure your fixed asset purchases are treated correctly and your tax relief is maximised.