The Tax Plan published with the Spring Statement on 23 March confirmed a desire to incentivise businesses to undertake more capital investment, with a view to boosting growth and productivity in the UK economy. The capital allowances regime was cited as one way that such incentives could be given.

HM Treasury subsequently published a policy paper, inviting views on a number of alternative suggestions for reforming plant and machinery allowances in order to provide greater incentives. These include:

• increasing the permanent level of the annual investment allowance (AIA);
• increasing the rates of writing down allowances (WDAs);
• introducing general first-year allowances (FYAs) for qualifying expenditure on plant and machinery;
• introducing an additional FYA; and
• introducing permanent full expensing.

In its response to the policy paper, ICAEW’s Tax Faculty has suggested that there are several limitations to the current regime as a source of incentives for capital investment. This is because:

• allowances are given some time after the expenditure has been incurred (and in the absence of 100% FYAs, these are given over a number of years);
• from an accounting perspective, the allowances impact the tax line, not the profit before tax figure. Furthermore, due to the existence of deferred tax, the overall impact on the tax line can sometimes be zero; and
• allowances tend to be given on a blanket basis, without any differentiation between industries or how assets are used.

From discussions we have had with ICAEW members, the overall impact appears to be that capital allowances are seen by businesses as a reward for making capital investment rather than as an incentive to do so. In this article we consider ways that the government could tip the balance from reward to incentivisation.

Shift to a tax credit-based system

One key characteristic of the capital allowances code is that it is a deduction-based regime. Even the super deduction, available to companies until 1 April 2023, is given by way of deduction from taxable profits. This causes a particular problem for loss-making businesses as they do not have any profits against which to offset the deduction. It is possible to disclaim capital allowances and claim them in a subsequent period when the business starts making a profit, but that just moves the timing of the benefit further into the future.

Even if the business is making a profit, unless 100% FYAs are given, the expenditure will be pooled. This makes it difficult to identify the exact amount of tax relief obtained in relation to any specific item of expenditure.

Allowances are given in these pools on a reducing balance basis. This means that it takes longer for relief to be given on the expenditure than if a straight-line basis were used, further weakening any cash-flow incentive provided by the regime

By contrast, a tax credit-based system would provide businesses with a tax cash benefit that could be obtained relatively quickly after the relevant claim was made. Businesses would see an identifiable amount of credit coming back that is directly related to the expenditure incurred. Businesses may even increase the amount of the expenditure they make by reference to the amount of the credit, knowing the funds are coming back.

The government could decide to move wholly to a credit-based system, or only make this available in respect of certain categories of expenditure. For example, the Piano Transizione 4.0 introduced in Italy provides for tax credits of between 6% and 40% in relation to expenditure on fixed assets acquired for the purpose of the technological and digital transformation of production processes.

Give an ‘above-the-line’ cash benefit

Decision-makers in larger listed businesses tend to focus on the impact their decisions make on EBITDA and profit before tax. A tax credit that qualifies as an income item above the tax line would therefore provide a greater incentive for those people than a deduction from taxable profits.

The most obvious comparative regime is the UK’s own research and development expenditure credit (RDEC). Under the RDEC, a company receives a tax credit of 13% of eligible expenditure. The credit is then taxed at the usual corporation tax rate if the company is profit-making.

Companies receive the credit as a cash payment or a reduction on their corporation tax bill depending on their financial position. Loss-making companies receive a cash credit, and profit-making companies receive the reduction.

The government might decide to move completely to a tax credit-based system, or it could provide this only in respect of certain types of expenditure. This might prove a useful incentive to nudge businesses into certain types of behaviour (eg, the acquisition of environmentally friendly assets).

Making capital allowances more rewarding

Over the past 15 years, successive chancellors have made incremental changes to the capital allowances system. This has created uncertainty and has slowly reduced the cash-flow benefit of the tax relief. 

The main rate pool’s WDA has fallen from 25% per annum to 18%, while the WDA for the special rate pool has almost halved, falling from 10% to 6% per annum. The rate reductions have not only reduced the incentive to invest, they also do not reflect how long assets are used by businesses. 

The AIA has also experienced constant change. There have been seven different limits over the course of 11 years, ranging from £25,000 per annum to £1m per annum. This has made it difficult for many businesses to make investment decisions with certainty over the amount of allowances that will be available.

Should the government decide to continue capital allowances in their current form, a guarantee that the amount of the AIA will remain stable for several years and a return to the more beneficial rates of relief would be welcomed by business. 

Distinguish between expenditure types

Successive governments have introduced initiatives that have provided special FYAs for certain types of projects. These have included the business premises renovation allowance, flat conversion allowance and enhanced capital allowances. Although not strictly a capital allowance, land remediation relief continues to attract relief at 150% for eligible expenditure, with a tax credit available for the surrender of a qualifying loss. Although these reliefs had their limitations, be it a lack of investor awareness, or legislative restrictions, they were all designed to encourage specific forms of investment. 

One of the overarching aims of the government’s tax plan is to incentivise investment in general. But it might be best able to do this if it encourages specific types of expenditure that also help achieve its other policy aims, such as:

• carbon reduction, including the commitment to reaching net zero by 2050;
• the Levelling Up agenda; and
• helping manufacturers expand their activities and exports.

There are many countries operating focused environmental reliefs from which the government can take inspiration. Examples include:

• a 9% tax credit available for investments linked to environmental protection in Luxembourg;
• preferential tax deductions for certain prescribed environmental protection facilities in Hong Kong; and
• 100% FYAs for environmentally friendly machinery and equipment in Mexico.

Conclusion

The government has an array of inspiration available to design tax policies that make a real difference to meeting its policy objectives. This makes the range of options set out in the policy paper particularly disappointing. If it is serious about rewarding capital investment, it should identify the challenges and limitations of the current system and consider innovative solutions to address these. Hopefully, the suggestions in this article will provide a good starting point. 

About the authors

Paul Vohmann, Associate Director, Capital Allowances, Grant Thornton UK LLP

Richard Jones, Business Tax Manager, Tax Faculty