Definition of Balancing Charge
A balancing charge is a means of making sure you don't claim too much tax relief on the cost of an asset you buy for your business. It'll increase the amount of profit you have to pay tax on. A balancing charge is the opposite of a capital allowance, which reduces the amount of profit you have to pay tax on.
When you buy a large piece of equipment, you may be entitled to claim capital allowances on the cost of that item, either all at once via the Annual Investment Allowance (AIA), or spread over several years.
If you later sell that item for more than its "tax written down value", you'll need to add a balancing charge to your profit. The tax written down value is the amount you bought the item for, minus any capital allowances you claimed.
To calculate the balancing charge, add the amount you sold the item for to the capital allowances you claimed, then subtract the amount you originally bought the item for.
Example of a balancing charge:
Mary, a driving instructor, bought a car for her business six years ago for £11,500. She has claimed £5,000 worth of capital allowances on the car over its lifetime. Mary sells the car for £8,000. This amount is more than the tax written down value of the car (which is £6,500), so Mary needs to add a balancing charge to her profit to reflect this.
Mary calculates the balancing charge by adding the amount she sold the car for (£8,000) to the amount of capital allowances she claimed (£5,000), and then subtracting that figure from the amount she bought the car for (£11,500).
(£8,000 + £5,000) - £11,500 = £1,500 balancing charge.
Definition of the Annual Investment Allowance
The Annual Investment Allowance is a way to claim tax relief on many assets that your business will buy. It’s a kind of capital allowance.
If your business buys a piece of equipment that qualifies for the Annual Investment Allowance, you can deduct 100% of the cost of that asset from your business’s profit before you work out how much tax is due on that profit. You can learn more about what qualifies from HMRC.
The government sets a limit for how much Annual Investment Allowance a business can claim in a year, which means that if you buy assets costing more than the limit, you won’t be able to claim Annual Investment Allowance on all your assets. The limit was previously £200,000 but in January 2019 it was increased to £1,000,000. This change is now permanent.
If your business is registered for VAT, you claim the Annual investment allowance on the total cost of the asset less any VAT you can reclaim on that asset. If your business is not registered for VAT, you claim the Annual Investment Allowance on the total cost of the asset.