Depreciation vs Capital Allowances — Why They're Not the Same Thing (2026)

The Short Version

Depreciation is an accounting figure that spreads the cost of an asset over its useful life and reduces your accounting profit. Capital allowances are the tax version — the standardised relief HMRC actually allows. Because HMRC won't accept depreciation (every business could pick its own rate), depreciation is added back when working out taxable profit, and capital allowances are deducted instead. Same van, two completely different numbers.

Depreciation vs Capital Allowances at a Glance

What Depreciation Actually Is

When you buy a capital asset — a van, a digger, a welding plant, a set of power tools — you don't put the whole cost into your profit and loss account in the year you buy it. That would distort the picture: one big purchase could turn a profitable year into a loss on paper, even though the asset will keep earning for you for years.

Instead, accounting spreads the cost across the asset's useful life. That spread is called depreciation. It's a genuine expense in the accounts that reduces your accounting profit and reflects the wear and tear on the asset over time. There are two common methods:

• Straight-line: the same amount each year. A van costing £20,000 with an estimated 5-year life depreciates by £4,000 a year (£20,000 ÷ 5).
• Reducing balance: a fixed percentage of the remaining value each year, so the charge is higher early on and tapers off. A 25% reducing-balance rate on that £20,000 van would be £5,000 in year one, then £3,750 the next, and so on.

Either way, depreciation is an estimate. You're guessing the useful life and choosing the method. That flexibility is exactly why it works for accounting but not for tax.

The Key Point: HMRC Doesn't Accept Depreciation

Here's where most of the confusion comes from. Depreciation is not an allowable expense for tax. HMRC does not let you deduct it when working out your taxable profit. The reason is consistency: if depreciation were deductible, every business could choose its own life and method, and two identical businesses could end up with wildly different tax bills purely because of accounting choices.

So when your taxable profit is calculated, depreciation is added back to your accounting profit. In its place, you claim capital allowances — HMRC's own standardised version of tax relief on capital assets. The same van therefore gets depreciation in the accounts (which is added back) and capital allowances for tax (which is deducted). Two systems, one asset.

What Capital Allowances Are

Capital allowances are the tax relief you claim on qualifying capital purchases — broadly "plant and machinery", which for a trade business covers vans, tools, equipment, machinery and similar assets. The main types are:

• Annual Investment Allowance (AIA): gives 100% relief on qualifying plant and machinery in the year of purchase, up to the annual limit. For most trade businesses this is the big one — buy a £20,000 van and, if it qualifies, you can write the whole £20,000 off against profit in that year.
• Writing-down allowances (WDAs): for spend above the AIA limit, or assets that don't qualify for AIA, you claim a set percentage of the "pool" value each year. The standard pool rate is fixed by HMRC and the relief carries on year after year on the reducing balance.
• First-year allowances and full expensing: companies can use full expensing for qualifying new plant and machinery, giving 100% relief in year one outside the AIA. The exact reliefs available depend on whether you're a sole trader or a limited company.

The headline difference: depreciation drips the cost out over years, whereas the AIA often gives you the whole lot back in year one. That makes capital allowances a faster form of relief for most trade purchases.

Why Two Systems Exist

It can feel like needless duplication, but the two systems serve different masters. Accounting depreciation exists to give a true and fair view of the business — it matches the cost of an asset to the years it actually helps generate income, so your accounts reflect economic reality.

Capital allowances exist to make tax fair and consistent across businesses. By fixing the rates and the rules, HMRC stops businesses gaming their tax bills through aggressive or generous depreciation policies. Both numbers are "correct" — they're just answering different questions.

A Worked Reconciliation Example

This is where it clicks. Say your trade business made an accounting profit of £30,000 for the year, and that figure already has £4,000 of van depreciation taken off it. In the same year, you bought a van for £20,000 that qualifies for AIA. Here's how the taxable profit is worked out:

So the accounting profit is £30,000, but the taxable profit is only £14,000 — a £16,000 difference, in one year, driven entirely by the way depreciation and capital allowances interact. This is why your accounting profit and your tax bill rarely line up, and why a big asset purchase can slash your tax in the year you make it.

The Timing Difference Matters

Notice what happened in the example: depreciation only knocked £4,000 off the accounts, but the AIA knocked the full £20,000 off the tax computation. Capital allowances, via the AIA, often give faster relief than depreciation.

The flip side is that the relief is front-loaded. In future years, that van will keep depreciating in the accounts (another £4,000 a year on straight-line), but for tax you've already claimed the lot — so there are no more capital allowances on it to deduct. That's why the numbers can swing dramatically year to year: a heavy-investment year shows low taxable profit, while a quieter year with no big purchases can show taxable profit well above your accounting profit, because the added-back depreciation isn't matched by fresh allowances.

The Cash Basis Works Differently

If you're a sole trader using the cash basis rather than traditional accruals accounting, the picture changes. Under the cash basis you generally record income and expenses when money actually moves, and most asset purchases — tools, equipment, machinery — are simply deducted as an expense when you pay for them, rather than being depreciated and run through capital allowances.

There's a notable exception: cars are still dealt with through capital allowances even under the cash basis. So a plumber on the cash basis can just expense a new set of tools when bought, but a car would follow the capital allowances rules. If you're unsure which basis you're on, your accountant or your latest tax return will tell you — it changes how purchases are treated.

What This Means in Practice

For day-to-day running of your trade business, you don't need to do the add-back and the capital allowances computation by hand — that's your accountant's job, and they'll handle the reconciliation when they prepare your accounts and tax return. But understanding the difference helps you in three ways:

• You can read your own accounts. When you see depreciation reducing your profit but it doesn't change your tax, you'll know why.
• You can time big purchases. Because the AIA gives relief in the year of purchase, the timing of a van or machinery buy can have a real effect on the tax due for that year.
• You can have a better conversation with your accountant. Knowing the vocabulary — add-back, AIA, writing-down allowances, pool — makes planning discussions far more productive.

Keeping clean records of what you bought, when, and for how much is what makes the whole computation possible. The better your purchase records, the more accurately your accountant can claim every allowance you're entitled to.

A Quick Recap

• Depreciation is an accounting figure that spreads asset cost over its useful life and reduces accounting profit.
• HMRC doesn't accept depreciation, so it's added back when calculating taxable profit.
• Capital allowances — mainly the AIA — replace it as the tax relief, often giving 100% relief in year one.
• This is why your accounting profit and taxable profit can differ a lot, especially in a big-purchase year.
• The cash basis handles most asset buys as straightforward expenses, with cars as the main exception.