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It is encouraging to see a full review of the Capital Allowances regime to assess its fitness for purpose now and in the future. The current regime has evolved over time since its introduction in the middle of the twentieth century, and even the latest Capital Allowances Act is now twenty-one years old.
This review is timely. The last few decades have seen a downward trend in both the Corporation Tax rate and the value of Capital Allowances – both in terms of Writing Down Allowance (WDA) and of cash value. At a macro level, this has contributed to the UK’s shift away from capital-intensive industries and towards a knowledge economy significantly dependent on imported goods and materials.
We’ve all seen the resilience of global supply chains be repeatedly stress-tested in recent years. Brexit, Coronavirus, the war in Ukraine and even the container ship wedged in the Suez Canal have served to underline the strategic importance of at least some level of national self-reliance.
This review of Capital Allowances should be seen as the ideal starting point from which to strategically reframe the UK economy to favour long-neglected capital-intensive industries, thereby broadening the base of the economy and reducing reliance on imports.
Simultaneously this opportunity should be used to increase the UK’s international competitiveness in attracting foreign investment.
As the only tax relief available on capital expenditure, Capital Allowances are naturally a very important consideration for capital-intensive businesses. When financial models are developed for a large investment in plant or machinery, the availability of Capital Allowances can have a significant effect on the payback period for a project, and even on its outright viability.
We frequently see Capital Allowances factored in to investment appraisals for developments of wind farms, solar farms, mixed-use regeneration projects and other large-scale capital projects.
In our experience, most large-scale investors use appraisal methodologies that consider cashflow over the lifespan of the project and/or their investment horizon, adjusted to account for the net present value of the cashflows.
Signs indicate that the era of historically low inflation is ending; for years it’s been easy to overlook the way inflation erodes the benefit of Capital Allowances. Net Present Value calculations will become ever more significant.
While marketed as a generous tax incentive, in actuality the Super-Deduction is simply the removal of a disincentive to invest: why invest now and receive relief at 19% if postponing the investment would yield relief at 25% when the Corporation Tax rate rises?
Consequently, the Super-Deduction was announced at very short notice and is in place for a relatively short window of time. When making significant capital investments, businesses plan some way into the future. It is perhaps possible that existing investment plans were brought forward but we haven’t seen any cases where the Super-Deduction generated additional investment. In most cases, the extra relief was simply seen as a welcome and unexpected bonus rather than an actual incentive.
In a post-Brexit world, we can’t ignore the relevance of tax policy to the UK economy’s international competitiveness, so it is pleasing to see this item on the agenda.
Following the OECD deal to impose a global minimum corporate tax rate of 15% from 2023, agile and entrepreneurial countries will begin to shift the focus of their Corporation Tax policy from tax rate to tax base.
Capital Allowances will soon find themselves on the front line of the global battle to attract inward foreign investment, yet the UK regime is currently uncompetitive and complex and offers limited amounts of certainty or predictability.
The general level of awareness of Capital Allowances among SMEs is low. Where there is awareness, in a business of any scale in any sector, that awareness extends as far as the existence of Capital Allowances and a (not unreasonable) belief that the rules are complicated and ever-shifting.
The system as it stands is complex and many-faceted.
Structures and Buildings Allowances (SBAs) appear at first glance to be simple but introduce endless layers of complexity as soon as you scratch the surface. The SBA regime sets aside many long-established principles of Capital Allowances and creates its own parallel rules to no clear purpose. Why for example must SBAs be clawed back in Capital Gains Tax, when this has never been the case for any other Capital Allowance? There are many practical examples where it is unclear which expenditure is eligible for SBAs, and the rules around establishing when a building is deemed to have been ‘brought into use’ are extremely muddy.
The Allowances Statement requirement imposes on taxpayers record-keeping demands that stretch for up to 33 years; the clock restarting with every claim for any works to the property however minor. I have encountered very few taxpayers for whom the extremely low rate of relief spread across such a long time horizon makes a claim to SBAs worthwhile, and when made aware of the admin burden many businesses have chosen simply not to bother making a claim.
Similarly, the Annual Investment Allowance (AIA) appears to be straightforward but the transitional rules for its reduction back to £200,000 are anything but.
For Plant and Machinery bought as part of a second-hand property transaction, the current regime of Mandatory Pooling is incredibly complex and badly understood. To incorporate Mandatory Pooling into real-world transactions, a system of cumbersome workarounds has evolved that add to the administrative burden of accessing the investment incentive.
Above all else, taxpayers value certainty and predictability, which must become a priority in any tax policy.
Investment decisions about assets that may have a payback period measured in decades are based on financial models that rely on a confident expectation of future tax policy.
The Super-Deduction is just a short-term bridge to remove a temporary disincentive to invest. The SBA regime is unnecessarily complicated and of negligible cash value. The AIA is forever on a cliff edge. None of these do anything to support strategic investment decisions: while businesses will always welcome temporary tax give-aways, they lead at best to a short-term boost in investment. It is far more likely that investment plans are merely rescheduled but that the overall level of investment is not affected.
We’ve seen endless tinkering with the AIA, which has been given several consecutive stays of execution. The AIA needs to be set at a level permanently, to give businesses confidence in their investment appraisals.
The WDA for both pools of Plant and Machinery has been eroded over many years. The rates no longer reflect the life expectancy of an item of plant, which has shortened due to developments in technology.
A low WDA for integral features discourages property owners from updating a building’s services. This is counterproductive in the drive towards net-zero and limits the benefits that can be achieved by progressive tightening of energy efficiency and building control standards. Against a background of record-high energy costs – and in concert with tightening environmental standards – a higher WDA will result in payback periods being shortened. The business case for replacing elderly plant with new energy-efficient equipment will be easier to make when reduced running costs are set alongside lower post-tax capital cost.
There is no benefit to persisting with two separate rates of WDA. Special Rate Pool (SRP) items should attract the main rate of WDA, and the SRP should be abolished. The WDA should be increased to 25%. It should also be applied on a straight-line basis to mitigate the erosion of value imposed by inflation.
The WDA for SBA should be increased to 10% to make it a worthwhile incentive and to better reflect the real-world life expectancy of commercial property. The CGT claw-back should be removed, and documentation requirements should be reviewed with a view to simplifying the administration burden.
FYAs add significant complexity and achieve very little in additional investment incentive when compared to other options such as increasing WDA.
Full expensing will be very costly for the treasury and removes any ability to target tax relief. Permanent full expensing will allow businesses to choose their own Effective Tax Rate unless many complicated anti-avoidance rules are drafted. These rules will add significantly to the compliance burden and will undermine the major benefit of this option, being its supposed simplicity.
It is not clear why every recent change to the Capital Allowances regime has taken a punitive stance towards the PBSA sector. HMRC’s revised definition of ‘residential accommodation’ issued in October 2010 resulted in a large proportion of the expenditure on a PBSA development being excluded from eligibility for CAs, and also thereby from the Super-Deduction. The sector even suffers from a carve-out from SBAs that denies relief for expenditure on any part of a building that contains even a small proportion of student accommodation.
While of course there will inevitably be a need for anti-avoidance measures for second-hand plant, Mandatory Pooling should be swept away in its entirety. Ideally it would be replaced with investment in adequate HMRC scrutiny of Capital Allowances claims; improved policing will help to weed out rogue or mistaken claims. The historical approach of introducing ever higher hurdles such as Mandatory Pooling serves only to add compliance burden to the legitimate claimant, while rogue taxpayers simply overlook any additional rules and continue as before.
As touched on above, the drive for net-zero is hampered by Mandatory Pooling: the compliance burden and restriction of relief to inflation-eroded historic cost does not reflect the true cost to a business of bringing an asset into use, and thereby discourages the reuse of existing properties in favour of building anew.
Similarly, while not a specific Capital Allowance matter, the differing VAT treatment for the redevelopment of existing property compared to that for a new build is counterproductive to the laudable sustainability aims. Newfound freedoms post-Brexit should be utilised to address this damaging discrepancy.
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