Depreciation for Self-Employed vs. Private Limited Companies – Detailed Explanation

What Is Depreciation?

Depreciation is the reduction in value of an asset over time due to wear and tear, usage, or obsolescence. Businesses use depreciation to spread the cost of assets over their useful life rather than deducting the full cost in the year of purchase.

1.    Self-Employed (Sole Traders & Partnerships)

How Assets Are Treated for Tax Purposes

For sole traders and partnerships, depreciation is not an allowable tax deduction. Instead, they claim Capital Allowances, which provide tax relief on business assets such as:
✅ Machinery
✅ Equipment
✅ Vehicles
✅ Business-related fixtures (e.g., office furniture)

Types of Capital Allowances for Sole Traders

Annual Investment Allowance (AIA)

  • Allows 100% deduction of the cost of qualifying assets in the year of purchase.
  • AIA limit is £1 million per year (as of 2024).
  • Example: If a self-employed plumber buys a van for £30,000, they can deduct the full £30,000 from profits using AIA.

Writing Down Allowance (WDA)

  • Used for assets not covered by AIA or exceeding AIA limits.
  • Applied as a percentage of the remaining asset value each year:
    • Main Pool (18%): Most machinery, equipment, and vehicles.
    • Special Rate Pool (6%): Includes long-life assets, integral building features (e.g., lifts, heating systems).
  • Example: A photographer buys a camera for £10,000 but does not use AIA. They can deduct £1,800 (18% of £10,000) in the first year, then 18% of the remaining balance in future years.

First-Year Allowance (FYA)

  • Available for energy-efficient and environmentally friendly assets (e.g., electric cars, zero-emission equipment).
  • Allows a 100% deduction in the first year.
  • Example: Buying an electric van for £40,000 allows a full £40,000 deduction under FYA.

2. Private Limited Companies (Ltds)

Unlike sole traders, limited companies do record depreciation in their accounts, but it is not tax-deductible. Instead, they use Capital Allowances to reduce their taxable profits.

How Companies Handle Depreciation

📌 Depreciation is recorded as an accounting expense but must be added back when calculating taxable profits.
📌 Capital Allowances (AIA, WDA, FYA) determine the actual tax relief a company can claim.

Example of Depreciation & Tax Adjustment for a Company

A limited company buys machinery for £50,000. It applies straight-line depreciation over 5 years:

  • Depreciation charge in accounts = £10,000 per year.
  • This £10,000 is added back when calculating taxable profits.
  • Instead, the company claims Capital Allowances (e.g., AIA or WDA) for tax relief.

Types of Capital Allowances for Limited Companies

Ltd companies use the same Capital Allowances as sole traders, but with a few additional options:

1️ Annual Investment Allowance (AIA) – 100% deduction up to £1 million per year.
2️ Writing Down Allowance (WDA) – For assets not covered by AIA:

  • 18% for general assets
  • 6% for special rate assets
    3️    ⃣ Super-Deduction (Now Replaced by Full Expensing)
  • From April 2021 to March 2023, companies could claim 130% of asset costs.
  • This has now been replaced by Full Expensing (100% deduction) from April 2023.
    4️    ⃣ Full Expensing (from April 2023)
  • Limited companies can claim 100% tax relief on qualifying plant and machinery with no limit.
  • Applies only to new (not second-hand) assets.

Example of Full Expensing for Companies

A company buys factory equipment for £100,000 in 2024.

  • Under Full Expensing, it can claim 100% of the cost in year 1, reducing taxable profits by £100,000.

3. Key Differences: Sole Traders vs. Ltd Companies

Feature

Self-Employed (Sole Trader)

Private Limited Company (Ltd)

Depreciation in accounts?

❌ No

✅ Yes

Depreciation is tax-deductible?

❌ No

❌ No (added back for tax)

Capital Allowances used for tax relief?

✅ Yes

✅ Yes

Annual Investment Allowance (AIA) limit?

£1 million

£1 million

Full Expensing available?

❌ No

✅ Yes (only new assets)

Super Deduction (before April 2023)?

❌ No

✅ Yes (130% relief before 2023)

4. Tax Impact of Depreciation & Capital Allowances

How They Affect Taxable Profits

  • Sole traders & Ltd companies must add back depreciation when calculating taxable profits.
  • Capital Allowances reduce taxable profits, lowering tax bills.
  • Limited companies pay Corporation Tax (25% for most companies in 2024), so Capital Allowances help reduce their liability.

Example: Comparing Sole Trader & Ltd Tax Relief

Scenario:

  • A business buys a machine for £100,000.
  • Both a sole trader and a Ltd company claim AIA (100% deduction).
  • This means £100,000 is deducted from taxable profits, reducing tax liability:

Business Type

Taxable Profit Before Deduction

Deduction (AIA)

New Taxable Profit

Tax Rate

Tax Paid

Sole Trader

£150,000

£100,000

£50,000

40% (income tax + NI)

£20,000

Ltd Company

£150,000

£100,000

£50,000

25% (corporation tax)

£12,500

5. Final Thoughts & Best Practices

For Sole Traders

✔️ Use AIA to claim full tax relief in year 1 where possible.
✔️ If AIA is used up, apply WDA (18% or 6%).
✔️ Consider FYA for energy-efficient purchases.
✔️ If planning to incorporate, check how assets will be treated in transition.

For Limited Companies

✔️ Record depreciation in accounts but ensure it's added back for tax purposes.
✔️ Use Full Expensing (100% relief) for new plant & machinery.
✔️ If Full Expensing doesn’t apply, claim AIA (£1M cap) or WDA (18% or 6%).
✔️ Plan purchases to maximize tax relief each year.

Would you like a breakdown of specific assets (e.g., cars vs. vans), industry-specific guidance, or a worked-out example for your business? 🚀

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