How software companies can prepare for an R&D Tax Relief c...
It’s a great time to be an innovative software developer. The recent expansion of qualifying cate...
Change your region and language
Be sure to pick the location that matches your preferences.
Her Majesty’s Treasury released on 9 May 2022, a policy paper on Potential Reforms to UK’s Capital Allowances Regime. The publication was aimed at kickstarting a conversation with businesses about how to reform the UK’s capital allowances system.
Ahead of the end of the 130% super-deduction tax relief ending in April 2023, the government is keen to receive and assess consultation responses on potential reforms, in time for the Budget announcement later this year.
We are pleased to see that the government is seeking to reform the UK’s Capital Allowances Regime and consequently inviting views on potential changes. We also welcome the invitation to provide views in relation to the areas of interest covered by the Policy paper including the Spring Statement 2022 options.
We have participated in the conversation, by responding to Her Majesty’s Treasury’s Potential Reforms to UK’s Capital Allowance Regime” call for responses which was due on Friday 1 July.
In line with the Policy paper, our response provide with has been divided into five areas as follows:
With regards to evidence on the impact of capital allowances on capital investment decisions, based on our experience, we find that most of our clients are putting tax relief at the forefront of their decision-making process for capital investments. The capital allowances regime has a positive impact on investment and economic growth. Economists Eric Zwick and James Mahon demonstrated in a 2017 study that the impact of accelerated tax depreciation resulted in 2.1-2.5% increase for businesses that qualified for it versus those that did not. Elsewhere around the world, according to several economic studies such as Tax Policy and Business Investment by Kevin Hassett and R. Glenn Hubbard and Tax Compliance and Investment Incentives: Firm Responses to Accelerated Depreciation in China by Ziying Fan, and Yu Liu, investment growth is directly impacted by taxation.  Investment would usually increase the most for assets with higher cost recovery through capital allowances.
For example, we have had clients making different levels of capital investment ranged from hundreds of thousands to several million in the UK, but were set on finding out what tax relief they will be entitled to when the construction and fit out is completed. This includes overseas investors who feel more comfortable to invest or increase their existing investment portfolio in the UK when they know they are able to recover their capital cost quicker through capital allowances. The businesses were also keen to understand which of their business entities would benefit best from the tax relief in order to decide on which of the entities to structure the expenditure under.
Although their capital investment is expected to boost the growth of their business, and by extension the economic growth of the nation, business owners we work with in most cases will not make the decision on the investment until they have understood the capital allowances implication. Therefore, we believe that capital allowances is important to businesses in making capital investment decisions.
With regards to evidence on the impact of the super-deduction on investment decision making, a deciding factor for the majority of our clients since the introduction of the super-deduction has been understanding their eligibility for the scheme before making a decision on whether to proceed with the investment. In a number of cases, for the business it is a question of timing. Some of our clients who have expansion and investment plans affected by the impact of the Covid-19 pandemic on their business, have decided to go ahead with their capital expenditure on the basis that it will fall within the window of opportunity to claim the super-deduction.
Since the 130% first year super-deduction effectively provides almost 25p tax cash saving for every £1 spent under the current 19% headline Corporation Tax (CT) rate, some of our clients have been incentivised not to defer their capital expenditure until when the 25% CT rate kicks in as expected from 1 April 2023. We have also come across businesses that when considering capital investment, have decided to change their strategy of incurring the capital assets from their property company entity to their trading company entity in order to ensure they will benefit from the super-deduction.
Based on a study by Confederation of British Industry, super-deduction has significantly increased capital investment amongst UK businesses that qualify for it. This study which included 325 participating firms demonstrated that more that 50% of those firms were claiming super-deduction. The study also showed that super-deduction accounted for 41% of planned qualifying capital investment in 2021-2023. Furthermore, more than half of that investment would not have happened without the super-deduction. We therefore believe that super-deduction has positively impacted capital investment decision making. On the basis that there is no plan by the government to extend the super-deduction beyond 31 March 2023, it is recommended that the government should introduce other measures that will be equally beneficial to continue to spur capital investment and economic group.
Our views on some of the options for reforming the current system of capital allowances as set out in the Spring Statement 2022 are shown below:
Annual investment allowances (AIA)
The government is considering increasing the AIA permanent limit from £200,000 to £500,000 which will be a welcomed change amongst taxpayers. Although we note that this change could cost the Treasury £1 billion in a single year, it will be good to see the AIA limit increased beyond the additional £300,000. Considering that the current temporary limit is £1m until 31 March 2023, it would be prudent to extend the £1m temporary limit for at least another couple of years if the government would not be able to make it the new permanent limit.
Across our client base which incurs capital expenditure, the ability to claim and utilise the AIA is amongst top considerations. In fact, some businesses have had to bring forward their capital spend – particularly those qualifying as special rate items – before the AIA limit is reduced on 1 April 2023. The impact of a reduced AIA limit will surely be felt amongst taxpayers. Clearly, not all businesses will need to use up the £1m due to the quantum of their annual spend; however, the majority of heavy spenders will welcome an extension of the temporary limit or at least a £500,000 permanent increase.
Writing down allowances (WDA)
We note that the main and special deduction rates of WDA which is more or less the default avenue of getting tax relief on plant and machinery allowances, could also be increased from 18% and 6% respectively, to 20% and 8%. However, we find that because the nature of WDA means that tax deduction is at a reducing balance basis, some businesses are put-off by the slight layer of complexity it comes with. Although we note that the current proposed change could cost the Treasury £2 billion in a single year, some businesses would like to see WDA being changed to a straight-line deduction rather than a reducing balance scheme.
Assuming the straight-line deduction approach is adopted, even without increasing the 18% and 6% rates, it will provide more certainty and quicker access to tax relief. This approach will be welcomed by taxpayers. For example, on a £1m capital expenditure qualifying for special rate deduction at 6%, a reducing balance basis would mean that the relief will take more than 40 years to be claimed fully, whereas a straight-line deduction at the same 6% rate will mean that the relief will be available quicker at 16.7 years.
First-year allowances (FYA)
We note that the government is also considering a new first-year allowances scheme that will see for example 40% and 13% of immediate deduction available on main and special rate pool qualifying assets respectively. The balance of 60% and 87% will then be available in the default way through the WDA. We however note that this is adding an extra layer of complexity which taxpayers would like to see removed.
We think that this option will not be popular amongst taxpayers especially considering it is expected to cost the Treasury £3 billion in a single year based on the proposed 40% and 13% rates. A potentially more lucrative variation for businesses could be to offer a 100% FYA for main pool assets and 50% FYA for special rate assets. The balance of 50% on the special rate assets could then be claimed via the standard WDA rate. This alternative presents a more simplified approach.
Additional FYA allowances
We note that there is yet another variation of the first-year allowances reform which the government is also considering. We note that this will be in addition to claiming the default WDA. For instance, in addition to eligibility to claim WDA on £1m of qualifying capital expenditure, an additional 20% of allowances, that is £200,000 may be claimable in the first year. That means that an overall allowances of £1.2m or £300,000 of tax cash saving benefit (assuming 25% CT rate) will be claimable, albeit over a number of years. This has some similarities to the super-deduction scheme; however, the 130% super-deduction is designed to be claimable in full immediately.
In addition to a projected cost to the Treasury of £4 billion in a single year (based on additional 20% of allowances), we think that this change has the potential to further heighten the complexity of the capital allowances scheme. The complexity might attract reservation from taxpayers, however, considering that it provides more than 100% relief, it will be a more popular option when compared to the 40% and 13% FYA introduction above.
In modern British history, this is considered very generous and simplified. Businesses we have spoken to are excited about the prospect that this could potentially mean that when they spend £10m in acquiring any piece of plant or apparatus for carrying on their business activity, for example, they may be entitled to deduct the £10m immediately in full from their taxable profit in the year of expenditure. At an upcoming 25% CT rate, the immediate tax cash saving benefit would equate to £2.5m irrespective of whether they claim within a year or several years after they incurred the expenditure. This is far more generous than the immediate tax benefit expected in the current tax relief landscape (excluding the temporary super-deduction).
On the assumption that there will not be particularly complex accompanying rules, this option would appear to be a very simplified system that most businesses would welcome from our experience. One of the criticisms from businesses about the UK capital allowances system is the complexity of it. Full expensing will therefore be very popular amongst taxpayers should it be implemented.
It is, however, important to consider the cost implication to the Treasury. Currently no G7 government has implemented this on a permanent basis. Presumably, the expected huge cost implication has played a major part in this. With an estimate of £11 billion cost to the Treasury in a single year at its peak, full expensing is expensive and therefore the impact will need to be carefully considered. As a result, full expensing may be more suited as a temporary measure.
It is not surprising to see that the government is considering a number of reforms to make the capital expenditure tax relief landscape more lucrative for businesses. This is in line with the government’s commitment to boost the economy through tax reforms that incentivise business investment.
As lack of capital investment is considered one of the key causes of productivity issues in the UK, the government’s plan to invest £600 billion over the next five years is helpful; however, the private sector will need to boost their capital investment alongside. In addition to the unprecedented super-deduction tax relief, it is therefore necessary that the government continues to incentivise businesses through reform of taxes on business investment.
We have shared our opinion on the reforms being considered by the government, including alternative variations that may be more popular amongst businesses based on our experiences. It may be that not one option will be adequate, but a mixture of several options. For example, assuming the full expensing is considered too expensive to implement, it may be an idea to implement a scheme that provides 120% allowances as follows:
– 20% additional FYA
– 40% FYA for main pool assets and 13% FYA for special rate assets.
– The balance of 60% and 87% will then be available in the default way through
We hope that whatever plans are confirmed at Budget later this year will help boost and incentivise business investment to unprecedented levels.
Low carbon allowances
Another new capital allowances measure that could be introduced by the government and well received by businesses, may relate to a robust replacement of the now repealed Enhanced Capital Allowances (ECA) scheme on energy and water efficient assets. This new incentive could become known as low (or zero) carbon allowances (LCA). The LCA is also being recommended on the premise of the government’s effort towards environmentally friendly assets, and a green / sustainable future, in order to decarbonise all sectors of the UK economy. This includes the government’s heat and buildings (net zero) strategy which includes commercial and industrial properties. This ambitious net zero (emissions by 2050) strategy of the government, including setting out how the UK will unlock £90 billion in investment in 2030 is a good backdrop for a new energy incentive capital allowances scheme.
This will certainly be a welcomed addition to the capital expenditure tax relief landscape from the perspective of taxpayers and manufacturers of those assets. This will also go down well with the wider British population who recognise the need to act fast in doing whatever is possible to combat the adverse effects of global warming and to preserve a sustainable environment for future generations.
To achieve its potential, a number of measures such as robust and detailed stakeholder consultative process, as well as rapid and effective campaign to promote the scheme will be required. The latter will particularly go a long way in ensuring that the taxpayers are acutely aware to go and invest in specific qualifying assets. The former is expected to include a representation of manufacturers, taxpayers, tax advisors. Other relevant parties could include trade organisations, building contractors and consultants (like architects).
Capital allowances tax credit
We note that ECAs (as mentioned above) along with first-year credits were repealed with effect for expenditure incurred on or after 1 April (Corporation Tax) and 6 April (Income Tax) 2020. We find that businesses are put-off by the fact that they cannot benefit from any form of capital allowances tax credit (CATC) when they are loss-making. This is especially a concern when they know that tax credits like those available under the R&D Tax Credit and Land Remediation Relief schemes exist.
We would like to see a robust CATC scheme that will allow loss-making businesses to surrender their losses and still benefit from claiming capital allowances. This CATC measure can be introduced with a caveat that it can only apply when the taxpayer is not able to do a loss carry back and introduce capital allowances claim in a prior period when they were profitable.
Our capital allowances team of qualified specialists with diverse experience and multidisciplinary construction and financial skills, leverage on their expertise to maximise cash saving benefits for businesses who incur capital expenditure.
We provide a whole development lifecycle capital allowances advice from planning to design, construction, occupation and subsequent disposal or sale. This includes property sale and purchase transaction advise to support either the vendor to retain their capital allowances, or for the buyer to benefit from capital allowances on the purchase price paid.
Our general view on the current system of capital allowances is that some aspects of it are effective in incentivising taxpayers to invest in capital assets. This means that since accounting depreciation is not allowable for tax purposes, businesses we have worked with welcome the idea that they are allowed some form of tax depreciation through capital allowances. However, one of the constant recurring feedbacks from businesses is that capital allowances is not as generous as they would expect. For instance, clients expect to be able to tax depreciate their entire assets (including bricks and mortar) quicker rather than just their plant and machinery items. The structures and building allowances have been increased from 2% to 3%, however some businesses do not see this as enough incentive.
Majority of businesses we work with do find the complexity of the capital allowances system off-putting. The complexity ranges from what qualifies and what does not, as well as other aspects such as balancing adjustments which sometimes differ depending on the allowances being claimed. For businesses who believe they do not need to own their capital assets, they are discouraged by the complexity of the scheme such as rules around qualifying expenditure and length of cost recovery and as a result would rather rent spaces and equipment instead.
At the annual Mais lecture held at the Bayes Business School on 24 February 2022, the Chancellor stated, “capital investment by UK businesses averages just 10% of GDP, considerably lower than the current OECD average of 14%”. In his Spring Statement 2022, the Chancellor also alluded to the fact that, when compared with other countries, the tax treatment allowable in the UK for capital assets such as those qualifying as plant and machinery is much less generous that the OECD average. As a result, the Chancellor hinted on prioritising cutting taxes on business investment. This is particularly important considering that the 130% super-deduction is coming to an end on 31 March 2023. Based on a study by Confederation of British Industry, it is expected that capital investment by businesses in the UK would be increased by up to 40 billion a year by 2026 if the super-deduction is replaced with a similar permanent deduction. Some of the changes the government is considering will be attractive to businesses. In any case, it is hoped that whatever new reforms that come into effect in due course will boost and incentivise business investment to unprecedented levels.
We also find that businesses are put off by the fact that they cannot benefit from any form of capital allowances tax credit (CATC) when they are loss-making. This is especially disparate in contrast with the existence of tax credits such as those available under the R&D Tax Credit and Land Remediation Relief schemes. We also find that some businesses would have liked to see the Enhanced Capital Allowances (ECA) scheme on energy and water efficient assets revisited rather than outright repealed. We have provided more information on the CATC and ECA further down in our response.
Capital allowances can be claimed not only by companies, but also partnerships, individuals and overseas investors which carry out qualifying business activities such as a trade, property business, furnished holiday let, etc.
Are you planning to, or have you already incurred any commercial building or large-scale industrial and engineering plant related capital expenditure which may fall under any of the following categories?
New construction | Refurbishment works | Fit out works | Buying buildings
Please let us know as we can help you unlock and maximise cash tax savings and improve your business cash flow.
Head of Capital Allowances
t +44 20391 71494
 Lisa Hogreve, Daniel Bunn, Capital Cost Recovery across the OECD, Tax Foundation, Fiscal Fact No. 790 Apr. 2022, https://files.taxfoundation.org/20220425170932/Capital-Cost-Recovery-across-the-OECD.pdf
 Maffini, Giorgia, Jing Xing, and Michael P. Devereux. 2019. “The Impact of Investment Incentives: Evidence from UK Corporation Tax Returns.” American Economic Journal: Economic Policy, 11 (3): 361-89. DOI: 10.1257/pol.20170254
 Kevin A. Hassett, R. Glenn Hubbard, Chapter 20 – Tax Policy and Business Investment**RGH acknowledges financial support from Harvard Business School and the American Enterprise Institute., Editor(s): Alan J. Auerbach, Martin Feldstein, Handbook of Public Economics, Elsevier, Volume 3, 2002, Pages 1293-1343, ISSN 1573-4420, ISBN 9780444823144, https://doi.org/10.1016/S1573-4420(02)80024-6.
 Ziying Fan, Yu Liu, Tax Compliance and Investment Incentives: Firm Responses to Accelerated Depreciation in China, Journal of Economic Behavior & Organization, Volume 176, 2020, Pages 1-17, ISSN 0167-2681, https://doi.org/10.1016/j.jebo.2020.04.024.
Explore our latest insightsView more! arrow_forward
How software companies can prepare for an R&D Tax Relief c...
It’s a great time to be an innovative software developer. The recent expansion of qualifying cate...
How to work out your business rates
Business rates are taxed on most non-domestic properties in the UK, including shops, offices, pub...
Information & Communication Industry UK R&D Tax Credit...
With software and technology advances continuing to shape how we live and work, the Information &...
Manufacturing Industry UK R&D Tax Credit Expenditure
R&D and manufacturing go hand-in-hand as the sector significantly contributes to the UK’...