Depreciation vs capital allowances comes down to one idea: depreciation is how your accounts spread the cost of an asset, while capital allowances are the tax relief HMRC gives for the same purchase. Your accountant adds back the first and deducts the second, which is why your company's accounts and its tax return rarely show the same profit. This guide shows you where to find each figure, and how to read your own corporation tax computation line by line.
Key takeaways
- Depreciation is an accounting estimate. HMRC does not allow it as a tax deduction.
- Capital allowances replace depreciation in the tax computation, at rates set by law.
- A big purchase can produce a tax loss even when the accounts show a profit.
- When you sell an asset, the tax and accounting results often differ again.
What is depreciation?
Depreciation is the part of an asset's cost that is charged to the profit and loss account each year, because the asset is being used up. A £3,000 laptop expected to last three years might be depreciated at £1,000 a year. The directors choose the method and useful life, so two companies with identical laptops can show different depreciation. That flexibility is exactly why HMRC does not accept it for tax.
What are capital allowances?
Capital allowances are the statutory version. HMRC's capital allowances guidance explains that you can claim them on things you keep to use in the business, such as machinery, equipment and vans, instead of deducting their cost as an ordinary expense. For most small companies the main ones are the Annual Investment Allowance, which gives 100% relief up to £1 million a year, full expensing for new main-rate plant and machinery, and writing down allowances for anything else, including cars.
Side by side
| Question | Depreciation | Capital allowances |
|---|---|---|
| Where does it appear? | Profit and loss account and balance sheet | Corporation tax computation and CT600 |
| Who sets the rate? | The directors, following accounting standards | Tax law |
| Timing of relief | Spread over the asset's useful life | Often 100% in year one, otherwise a yearly percentage |
| Cars | Depreciated like any other asset | Usually writing down allowances based on CO2 emissions |
| On sale | Profit or loss on disposal in the accounts | Proceeds go into the pool; may create a balancing charge |
How to read your own tax computation
Ask your accountant for the corporation tax computation that sits behind your CT600. Then work through it in this order:
- Start with profit before tax from the profit and loss account. This figure already has depreciation deducted.
- Find the add-backs. Depreciation and any loss on disposal of assets are added back. Other disallowable costs, such as client entertaining, sit in the same section.
- Find the deductions. Any profit on disposal is taken off, then capital allowances are deducted.
- Check the capital allowances schedule. Each purchase should appear with the type of allowance claimed. Match them to invoices in your year-end file.
- Look for balancing charges where assets were sold. These are added to taxable profit.
- Confirm the result is the taxable profit on the CT600.
Illustrative example: a two-director joinery company
Illustrative example: the company and all figures are invented for this guide. Oakline Joinery Ltd has a 31 March year end. In the year to 31 March 2026 it made profit before tax of £48,000 in its accounts. During the year it bought a new table saw and workshop tools for £18,000, and sold an old van for £4,000. The van had cost £16,000 three years earlier and had a book value of £6,000 when sold, so the accounts show a £2,000 loss on disposal. The company used straight-line depreciation and charged £7,500 in the year.
| Line | Amount |
|---|---|
| Profit before tax per accounts | £48,000 |
| Add back: depreciation | +£7,500 |
| Add back: loss on disposal of van | +£2,000 |
| Less: Annual Investment Allowance on saw and tools | −£18,000 |
| Add: balancing charge on van (full cost was relieved when bought) | +£4,000 |
| Taxable profit | £43,500 |
The directors expected tax on £48,000. The real figure is £43,500, because the company got the whole cost of the new equipment relieved in one year, while the accounts will spread it over the equipment's five-year useful life. In later years the effect reverses: depreciation on the saw is still charged in the accounts but added back, with no allowance left to deduct. Knowing that in advance stops a higher tax bill in year two from looking like a mistake. For the rate that then applies, see our guide to marginal relief.
Common mistakes
- Expensing a large purchase in the accounts. Writing a £5,000 machine off as "repairs" overstates costs this year and understates the company's assets. Capitalise it and let the tax computation handle relief.
- Claiming AIA on a car. Cars are excluded. Check the business cars rules on GOV.UK.
- Forgetting disposals. A van sold privately or scrapped still needs to come out of the fixed asset register and into the allowances calculation.
- Treating depreciation as cash. It is not money leaving the bank, which is why cash flow and profit can tell different stories.
- Assuming 100% relief means the asset is free. Relief reduces tax at your company's rate. It does not refund the cost.
How we can help
We prepare company accounts with a clear fixed asset register and a tax computation you can actually follow. Company accounts start from £350/year and corporation tax returns from £250/year on fixed fees. See our company accounts service, our corporation tax service, check pricing, or contact us before your next big purchase.
Frequently Asked Questions
Why is my company's taxable profit higher than the profit in its accounts?
Often because depreciation and capital allowances differ. Depreciation reduces accounting profit but is added back for tax. If the capital allowances claimed that year are smaller than the depreciation, taxable profit ends up higher. In a year when you buy equipment and claim the Annual Investment Allowance, the opposite usually happens.
Can my company choose not to charge depreciation?
Not if you want accounts that follow the accounting standards. Assets that wear out should be depreciated over their useful life. The method and rate are judgements made by the directors and their accountant, but leaving depreciation out entirely would overstate the company's assets and profits.
Do company cars qualify for the Annual Investment Allowance?
No. Cars are excluded from the Annual Investment Allowance and from full expensing. They usually receive writing down allowances at a rate based on CO2 emissions, and some new zero-emission cars can qualify for a first-year allowance. Check the current car rules on GOV.UK before buying, because the rates have changed over time.
What happens for tax when the company sells an asset?
The accounting profit or loss on sale is ignored for tax, just like depreciation. Instead, the sale proceeds are brought into the capital allowances calculation. If you claimed 100% relief when you bought the asset, the proceeds usually create a balancing charge, which is added to taxable profit in the year of sale.
Is full expensing better than the Annual Investment Allowance?
Both can give 100% relief in the year of purchase, so for most small companies the result is the same. Full expensing has no cap but only covers new and unused main-rate plant and machinery. The Annual Investment Allowance also covers some used assets. Your accountant will normally claim whichever fits each purchase.
Related reading
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Schedule a consultation →Written by the Berber Accounts & Tax team, 124 City Road, London EC1V 2NX, United Kingdom.
Last reviewed: 2 November 2026.
This article is general information, not personal tax advice. Speak to a qualified accountant about your own circumstances before acting on it.