Capital allowances – time for reform?

In May, the Treasury published a policy paper setting out potential reforms to the UK’s capital allowances regime. The paper is surprisingly short compared to most consultations, with the main content amounting to just over three pages, and it has received relatively little fanfare to date. However, it has the potential to start a wide-ranging conversation about how the UK incentivises capital expenditure.

Why is reform being proposed now?

A review of the capital allowances regime was first announced by the Chancellor at the Spring Statement on March 23.

During his speech, the Chancellor highlighted that capital investment by UK businesses lags behind the OECD average and is a key driver of our lower productivity compared to France and Germany.  This, coupled with the expiry of the temporary super-deduction (which allows companies to deduct 130% of their qualifying capital expenditure) on March 31, 2023, has led the government to consider how best to support business investment and make the UK a competitive place to invest.

But this doesn’t mean we will necessarily see a significant giveaway in terms of making relief more generous, as any reforms will have to consider the broader economic climate. In particular, the Spring Statement documents note that the super-deduction is expected to cost around £10bn a year, and that any further support will have to align with the government’s fiscal objectives and ensure taxpayer money is effectively targeted.

What does the paper cover?

The policy paper outlines three main areas of interest in which input is sought:

• Investment decisions – how do firms make investment decisions? How important are capital allowances in those decisions and how are they taken into account?
• The super-deduction – what impact has this had on the investment decisions of businesses?
• The current system of capital allowances – how much do capital allowance rates influence investment decisions? What is the level of awareness of the current system? How easy is it to understand and operate? Does it provide adequate support for business investment?

In addition to these broader areas of discussion, the policy paper also seeks views on some specific options for reform.

What reforms are on the table?

The five specific reforms discussed in the policy paper are:

• Increasing the permanent level of the annual investment allowance (AIA) to £500,000
• Increasing the main rate and special rate writing down allowances (WDAs) from 18% and 6% to 20% and 8% respectively.
• Introducing general first year allowances (FYAs) of 40% for main rate expenditure and 13% for special rate expenditure.
• Introducing an additional FYA of 20%, whilst still allowing 100% of qualifying expenditure to be pooled.
• Allowing full expensing of qualifying main rate plant and machinery in the year expenditure is incurred, with a 50% FYA for special rate assets.

These options range from the simple and relatively conservative (e.g. increasing the AIA or WDA rates) to the more radical, and each comes with its own advantages and disadvantages. For example, an additional FYA or full expensing could provide a greater investment incentive than the timing differences arising from an increase in WDA rates or general FYAs, but they would be much more complex and potentially open to abuse.

Given the diverse nature of the businesses population claiming capital allowances, which ranges from the simplest sole trader to the largest multinational, it is unlikely that a ‘one size fits all’ solution can be found. In particular, whilst changes to the timing and level of relief may be of interest to larger businesses, they will have little to no impact on those smaller businesses which do not spend above the AIA threshold.

Therefore, it is disappointing that none of the options proposed address the inherent complexity of the current capital allowances rules, where too much depends on the precise timing of expenditure, fine statutory distinctions between similar types of assets and the nature and structure of a particular business. It is also a shame that more radical reform of the regime does not, at least for the time being, appear to be on the table.

What next?

Interested businesses, accountants and other stakeholders have until July 1 to comment on the issues raised in the policy paper, with a short online form provided to make feedback easier (longer responses can be submitted as an attachment).

The government has said they aim to make an announcement on reform in the Autumn Budget later this year. It will be interesting to see if this comprises a mere tweaking of rates or thresholds, or if the appetite is sparked for more detailed discussions.