Office of Tax Simplification – Future Capital Allowances Reform
Updated: Jun 15, 2020
The Income Tax Act 1945 put in place a system of capital allowances designed to encourage and assist the reconstruction of British Industry after the war. It was a rebalance and refocus of allowances that went back to 1878 reflecting the needs of the time.
Since then there has been a steady flow of rate and allowance changes to reward certain types of business investment to reflect the prevailing economic and government policy of the time. Now the allowances have an annual cost to HM Treasury of around £22.25bn arising from the reduced tax that would otherwise be collected. Not all capital investment is allowable for tax purposes and businesses in different parts of the economy benefit in their own way.
Of the £89.9bn of allowances claimed by companies in 2014-2015 roughly 20% was for businesses involved in mining and quarrying which is reflective of the plant intensive nature of the work involved. Plant and machinery allowances claims account for over 85% of all capital allowances claimed. More details on total claims per industry are shown in the chart below.
There have been many attempts to simplify the legislation now set out in the Capital Allowances Act 2001 but nothing as radical as set out in the Office of Tax Simplification’s report for an accounts based system which could see a significant extension of the assets eligible and alternative tax cash flows.
Most major changes to the tax system are normally accompanied by a policy objective to remain revenue neutral on government finances to meet fiscal requirements but this can often overlook the varied impact on sectors and the individual businesses operating within them affected to achieve this aim. There will be winners and losers, there always is, and any significant additional tax burden can alter behaviour and/or result in higher bills for consumers. The report recognises this and calls for further work to assess the costs and impact.
The report also challenges the role of capital allowances in investment decisions and calls on government for clearer statements on policy objectives not just to accompany any potential change but also any additional levers to influence capital investment goals. This is welcome. Capital allowances perform a mixed and not always successful role of partial business expense relief and investment incentive.
A simplified and targeted capital allowance system should reflect our current needs. For example, that rewards investment in good affordable housing; better and more integrated transport & technology infrastructure; greener buildings and vehicles; and a more diverse geographic economic base.
We are thankfully not recovering from the devastating effects of a world war but in 2017 we are facing very significant economic, social and political challenges. It is only right that our tax system and specifically, the levers used to reward major capital investment are fit for what lies ahead.