For any self-employed individual a key conversation to have is whether the Mileage Rate is a better alternative to depreciation. But first, we need to think about depreciation. Depreciation isn’t actually allowed for tax purposes. So, while the business is free to depreciation the motor vehicle at any percentage best suited to the needs of the business, this amount is actually added back before the tax is calculated.
Instead, the government has a standardised version of depreciation called Capital Allowances. For motor vehicles, this broadly comes down to two different rates: 6% and 18% based on the emissions of the vehicle. Vans are treated differently, with the whole cost written off in the year of purchase. It is also worth noting that this isn’t option if you lease the vehicle.
Let’s assume the car costs £15,000 and is a high emissions vehicle. Using the available Capital Allowances, the taxable profits would be reduced by £900 in the 1st year, £846 in the second year and £795 in the third year. In addition to the Capital Allowances, the individual can claim the business proportion of fuel, maintenance and interest on any loans to purchase the motor vehicle.
Alternatively, instead of the Capital Allowances and the business proportion of the fuel, maintenance and interest, the individual could claim 45p per mile for the first 10,000 miles and a reduced rate for any mileage above 10,000 miles. Therefore, if the business has done 5,000 business miles, the individual could reduce their taxable profits by £2,250.
Now let us look at a couple of examples where the vehicle, car and van, costs £15,000.
Example: car and 5,000 business miles
If we consider an individual who has done 5,000 business miles.
Under the Capital Allowance method, they could claim £900 in the 1st year. If we assume £700 for maintenance and interest. The fuel cost would be £681, based on averaging 40 miles per gallon. A total reduction of £2,281 in the first year.
Alternatively, if the Mileage Allowance is used, 5,000 business miles at 45p per mile, results in a £2,250 reduction.
In this case, the annual reduction is broadly the same. However, to complicate matters, when you come to dispose of the car, there is likely to be a difference in the Capital Allowance balance and the market value – with the Capital Allowance valuing the car more than what it can be sold for. This difference can be used in the year of disposal to reduce your profits.
Example: van and 20,000 business miles
Vans are treated differently to motor vehicles, the full amount can be written off under Capital Allowances in the first year.
Therefore, if we assume £2,000 for maintenance and interest and 20,000 miles in a van capable of 30 miles per gallon, a fuel cost of £3,600. In year 1, the taxable profits can be reduced by £20,600. In the second year, as the van has already been considered, the taxable profits can only be reduced by £5,600.
Alternatively, the Mileage Allowance would allow a constant £7,000 allowance each year.
Over three years, the Capital Allowance method would allow a total of £31,800 to be written off against the individuals income. The Mileage Allowance would only allow £21,000. However, just like with the car example above, as you can claim 100% of the cost in the year of purchase, when you come to sell, you need to add the amount you sold the van for. After three years, you might be able to sell the van for £7,000, therefore in the third year, you would have to pay tax on this £7,000.
Despite our efforts, this is still likely to be confusing, because it is complicated. But, here at Self Assessment Scotland, we’ll keep you right, we get in touch with our clients and we ask straight forward question and complete some modelling to advise you on which method is more appropriate for your individual circumstances.