Updated: May 11
Following its Spring Statement, the government now wants your views on ongoing potential capital allowances reform and has published survey details with links for completion by 1 July 2022 for consideration in this years Autumn Budget.
The UK tax regime is not as generous as other OECD countries when it comes to rewarding capital investment and businesses are not investing to the same levels as their OECD counterparts (10% compared to 14% average). Lower investment is understood to be a key factor in the UK's lower productivity compared to Germany and France.
To what extent capital allowances influence investment decisions is a much debated topic so it should come as no surprise that the government is specifically interested in views on capital allowances and business investment decisions.
It is worth noting that wholesale reform of the capital allowances system was examined by the Office of Tax Simplification less than five years ago and specifically, to replace it with an accounts based system. The report concluded "that the undoubted simplification benefits would not be worth the disruption of the wholesale upheaval involved. As only 30,000 businesses claim capital allowances in amounts exceeding the level of the Annual Investment Allowance, we consider that the focus should be on improving the existing system".
This means capital allowances are likely to remain the primary means businesses get tax relief for investment in property, plant and equipment, so when the temporary 130% Super Deduction Incentive and £1 million Annual Investment Allowances come to an end on 31 March 2023 the government wants alternatives that utilise the framework of the current system.
Any changes are expected to coincide with an increase to the UK corporation tax rate from 19% to 25% (for profits over £250,000) so the value of allowances (and specifically any enhanced allowances) is expected to become more significant to the taxpayer and costly to HM Treasury.
The options raised for plant and machinery investment will have a different impact on each business so it is important to make sure your voice is heard and if you would like to discuss the proposals please do not hesitate to contact email@example.com.
The government is specifically interested to hear views on:
Investment decisions – evidence of how firms make investment decisions, the relative importance of capital allowances in those decisions, and how they are taken into account, such as by reference to net present values, cash-flow benefits or impacts on effective tax rates.
The super-deduction – evidence on the impact of the super-deduction into decision-making and views on how the super-deduction has affected the investment decisions of businesses.
International competitiveness of UK capital allowances – what more the capital allowances regime can do to support business investment, how far capital allowances rates influences decisions by multinationals on which territory to invest in including views on levels of awareness and how simple it is to understand and operate, and whether it provides adequate support for business investment.
Although sometimes overlooked as a more technical issue, capital allowances can have important economic impacts. Depending on their structure, they can either boost or slow investment which, in turn, impacts economic growth. The Tax Foundation - Capital Cost Recovery across the OECD, 31 March 2021.
Initial Observation Comments
Aside a stable set of allowances, the best way to push capital allowances on to board room agendas would be to have additional allowances (beyond asset cost) and a meaningful tax credit similar to R&D, where all businesses are encouraged to make capital investment in areas that meet the government's policy objectives.
Calculating the underlying benefit of capital allowances in investment decisions, particularly for real estate, is not straight forward. Not everyone involved pays tax and not everyone is entitled to the same types of allowances. Super Deductions are limited to companies within the charge to corporation tax and the Annual Investment Allowance is open to individuals (including partnerships) and companies but not trusts or mixed partnerships. First Year Allowances bring their own additional restrictions and then there are special rules for leased assets, transactions between connected persons and long-life assets (but only in certain assets and only if the amounts exceed £100,000).
Capital Allowances themselves are treated like a trading expense (receipt if balancing charge) so their value is directly affected by fluctuating tax rates and a businesses wider tax position.
To put that into a little context, a typical commercial office with a fitout value of £350,000 could have a current Year 1 tax saving of c.£67,000 (19%). After 2023, the same expenditure profile would generate a tax saving of between c.£41,000 (12%) and c.£54,000 (15%). The reason for the variance is the fluctuating corporation tax (CT) application (19% to 25% depending on profits). If the status quo of Super Deductions and AIA were maintained the same expenditure could generate a Year 1 tax saving of over £88,000 (25%) at the upper CT rate.
Every business intends to make a profit but it does not always work out that way, and new ventures in particular can have trading losses arising from set-up costs that can make the value of allowances less important in earlier years. Were a meaningful and simple cash tax credit alternative available instead (similar to R&D) then the profile and significance of capital allowances would undoubtedly be raised. Were this extended to non-tax paying investors such as Real Estate Investment Trusts (REITs) and pension funds its effects could be radical.
Another important factor is tax avoidance for which the landscape has fundamentally changed over the last 20 years. The government may wish for wealthy investors to put money into regeneration, community and green infrastructure, but there can be real concern over being entangled in a notifiable tax avoidance scheme with accelerated payment notices, enhanced HM Revenue & Customs (HMRC) scrutiny and potential reputation damage arising from marketed schemes that utilise capital allowances (legitimate or otherwise).
If the investor is only putting money in to get a tax advantage (as was often the case for reliefs like Business Property Renovation Allowance) their investment would, according to HMRC, be subject to the Disclosure of Tax Avoidance Schemes (DOTAS) rules and the enhanced scrutiny and risks associated. An alternative HMRC pre-approved scheme arrangement for capital allowances reliant schemes targeted at high net worth individuals could go some way to alleviate investor concerns, aide HMRC oversight and help achieve policy objectives in the chosen area of investment.
Traditional debt finance where the business borrows money to purchase qualifying assets is unlikely to affect the amount of any capital allowances claim (provided the loan is on normal commercial terms and the commercial expenditure is real) whereas, equity finance that involves a change in ownership can trigger the capital allowances loss buying rules and related anti-avoidance provisions.
The long finding lease rules are a provision designed to tackle tax-based leasing arrangements that utilise capital allowances; a market that has now substantially reduced since their introduction in 2006 and been over taken by other anti-avoidance tax measures yet those that make 'plant and machinery' investments for lease are still caught and can be subject to a very different tax profile.
Targeted anti-avoidance (AA) is a critical component of the tax system to deter and catch deliberate or unintended tax leakage but it must reflect changing policy objectives and wider AA legislation.
The Spring Statement Options
The government has initially proposed a number of 'plant and machinery' focused incentives:
Annual Investment Allowance (AIA) - increase the permanent level of the AIA from £200,000 to, for example, £500,000.
Writing Down Allowances (WDA) - increase the rates of WDAs from 18% and 6% to, for example, 20% and 8% (main rate and special rate pools respectively).
First Year Allowances (FYAs) - introduce general FYAs for plant and machinery, for example 40% FYA for 'main rate' (instead of 18%) and 13% for 'special rate' (instead of 6%).
An Additional FYA - an additional allowance added to 100% of the qualifying for expenditure, for example 20% to give relief above the assets acquisition cost.
Full Expensing - allow plant and machinery to be expensed in the year it is incurred with possible limitations (50%) for special rate pool to reduce cost.
Initial Observation Comments
There will inevitably be trade-offs with any of (1) to (5) above and whatever is introduced should not add complexity (it is notable that the new Super Deduction was accompanied by new disposal value rules). With the exception of Option 2, all the options are designed to benefit new expenditure to varying degrees.
One of the main challenges for expenditure on real estate and infrastructure is the segregation work needed to split the component parts into the correct tax pools for accuracy and claim optimisation, these latest proposals do nothing to alleviate that burden. Option (4) for an additional allowance combined with (1) or (5) would likely give taxpayers the highest relief.
The big challenge for any government is the cost of supporting capital investment. Even today, annual capital allowances claims exceed £100 billion and cost HM Treasury over £22 billion in tax revenue. They are now factored into the pricing cycles of many large businesses, notably the energy, water and waste sectors, even modest changes can have big consequences and need to be considered carefully.
An example of an important change is the standard corporation tax rate reduction in 2008 from 30% to 28% a decision which was forecast to cost HM Treasury around £2.2 billion annually but was largely offset by a reduction in the main plant WDA rate from 25% to 20%. At the same time, Industrial Building Allowances (IBA) were phased out which funded an increase in the 'special plant' WDA rate from 6% to 10% and clarification of 'integral features'. It was this year when the AIA was also first introduced at £50,000. Both the IBA and WDA changes were retrospective in that they affected both historical and new investment.
In balancing public spending there are trade-offs, and in 2010, the focus continued in reducing and simplifying corporation tax (with more targeted anti-avoidance) and help for SME businesses who account for around 10%, in terms of value, of all plant and machinery claims made. The AIA has now fluctuated from £50,000 to £25,000 to £250,000 to £500,000 to £200,000 to £1 million and without intervention will revert to £200,000 from April 2023. Standard WDAs reduced from 20% to 18% (main pool) and 10% to 8% (special rate pool) in 2012 to aide further CT rate reductions and more recently the 8% rate reduced to 6% to fund the introduction of Structures and Building Allowances (SBAs) from 2018.
Back in 1972 and shortly before the oil crisis and resultant economic shocks, investments in 'plant and machinery' qualified for 100% FYAs. By 1981, new investment in 'industrial buildings' could get a 75% initial allowances (20% for qualifying hotels and agricultural buildings) with any balance subject to writing down rates of 4%. Tax rates were of course significantly higher (the CT rate peaked at 52% for much of the 1970's and the top rate of income tax was 83%) but crucially if your business invested your effective tax rate would fall.
It was FYAs capital allowances that triggered an explosion in the leasing market for big ticket plant and machinery investment from trains, planes to oil rigs. In the 1980's, the original 100% Enterprise Zone Allowances (EZAs) were one of the key stimulus behind investment in much of London Docklands (including Canary Wharf) that remain celebrated today. These EZA's carried on, to varying degrees of success, through the use of 'golden contracts' until 2006.
Absent from the government's proposal are any targeted incentives to meet specific policy objectives. Expenditure in Freeport Tax sites which can qualify for 100% FYAs and 10% SBAs will cover only a small fraction of claims made. There are lots of issues to choose from to provide both enhanced and accelerated relief; not least: -
Improvements to existing commercial buildings to meet our collective carbon reduction targets (and help with operational cost reduction).
The re-vitalisation of many derelict and disused properties in our City, Town and Rural Centres post pandemic.
The transition to a green economy with infrastructure, technology and buildings to match.
We will be responding directly and if you would like to be kept up to date please contact us or sign up for our newsletter. Further details, including links to the survey, can be found here.