What is a capital asset? A limited company contractor’s guide

If you are a contractor working through your own limited company, you have probably come across the phrase “Capital Asset.”

But equally likely, in my experience, is that you’re unclear exactly what ‘capital asset’ means, and potentially, what distinguishes a capital asset from any other sort of asset. 

While there are many different types of Capital Assets, I want to focus here on those that a limited company IT contractor is most likely to purchase, writes Graham Jenner, founder of contractor accountancy firm Jenner & Co.

What is a capital asset?

A Capital Asset is an asset that the company is expected to use for more than a year. For a limited company contractor, examples would include:

1. A computer

2. A car (or van)

3. Specialist equipment (though not usually small tools)

You can think of the asset as helping to produce income for the company. If it is going to help produce income over a number of years, then it seems right that the cost of the asset should be matched against the income, in some way.

To achieve this, part of the cost is ‘written off’ against profits each year during its expected useful life. This is known as depreciation.

The alternative would be to set the whole cost off against income only of the year in which the asset is purchased. That would lead to lower profits in the year of purchase and higher profits in the other years in which the asset would be being used. For a contractor, that may not seem that significant, but consider a large printing company that buys a printing press costing say £1 million which might last them 20 years!

Capital assets and writing-off as a limited company contractor

So, why is it important limited company contractors DON’T write off the full cost of a Capital Asset in the accounts for the year of purchase?

1. Paying dividends – if the whole of the cost of an asset is set against the income of one year it will reduce the amount of profit available to take as dividends in the year.

2. Mortgage applications – if the company’s profit is reduced and, as a result, the shareholders income from dividends is reduced, this could hurt the ability to obtain a mortgage.

3. Other finance, such as HP on a car or home improvement loans – could be adversely affected.

4. Taxation – see ‘Tax treatment of capital assets,’ below

Tax treatment of capital assets

The tax treatment of capital assets is different to their treatment in accounts.

Capital allowances are given for tax purposes, which have their own rules, irrespective of the accounting treatment. The rules from HMRC are there to prevent businesses from obtaining full tax relief in the year of purchase.

Ironically, various tax incentives to invest in capital assets have been provided over the years, allowing 100% of the cost of certain assets to be claimed in the year of purchase. It should be noted, though, that these incentives are often of a temporary nature.

The current ‘Full Expensing’ capital allowance is only available from April 1st 2023 to March 31st 2026. Another allowance, ‘Annual Investment Allowance’, while permanent in nature, has limits on the total amount of expenditure which qualifies, which are changed from time to time.

Is it a bird? Is it a plane?

So, what about low value items such as printers and other computer accessories?

As many of these are likely to be used for more than a year, technically, they are a capital asset.

However, from an accounting point of view, due to their low value, it makes little difference whether you write them off in the year of purchase or over their useful life.

Directors have a duty to prepare and file accounts that show a true and fair view. Writing off a printer costing, say, £100, is not likely have a material impact on the truth and fairness of the accounts, and so writing it off in the year of purchase would be perfectly acceptable – and keeps things simple.

From a tax point of view, there is no official ‘de minimis’, so HMRC might expect even a £100 printer to be treated as a capital item! If the printer was written-off as a consumable in the year of purchase and if HMRC were to enquire into the company’s tax, and could be bothered to make any adjustment, they would add the £100 back to the profits and then deduct £100 in capital allowances, under the 100% rule!

How significant is all of this to a limited company contractor?

In reality, limited company contractors, are unlikely to incur sizeable capital asset costs, and the above parameters and details will not make a huge difference to any decision-making. However, you might be considering the purchase, by the company, of:

1. A car. Speak to your accountant first – the best advice may be NOT to buy it through your limited company.

2. Expensive specialist equipment (or a car). The treatment will follow the notes above – the good thing is that both will qualify for 100% tax relief in the year of purchase!