UK Capital Allowances After the Super-Deduction: Will Things Ever Be So Good Again?

On May 9, 2022, UK Chancellor Rishi Sunak published a call for evidence from businesses of all sizes to support his review of potential policy changes to the UK’s existing capital allowances regime. At the Spring Statement in March 2022, the Chancellor had already made it clear that the super-deduction will end, despite calls from businesses to extend this beyond March 2023. The current review is designed to see what impact the super-deduction has had and consider what should come next.

Never Had It So Good?

While there are qualifying conditions to be met, the capital allowances super-deduction is the most generous capital allowance that the UK government has ever created for corporate taxpayers. The super-deduction gives relief at 130% of an uncapped amount of qualifying cost, compared to the usual 18% writing down allowance for investment in main pool plant and machinery assets.

The special rate (SR) allowance gives relief at 50% of uncapped qualifying cost in the first year with the balance going into the normal special rate pool (for integral features to buildings and long-life assets) to be written down at the usual 6% rate in future years. The annual investment allowance (AIA) also gives 100% first year relief on the first 1 million pounds ($1.24 million) of qualifying investment for purchases up to March 31, 2023.

While this gives immediate tax relief of 24.7% super-deduction, 19% AIA and 9.5% SR, these reliefs are in fact not particularly generous in international terms. The Spring Statement document acknowledges this, referring to a 2021 comparison by the Tax Foundation, which puts the UK 30th out of 37 Organisation for Economic Cooperation and Development (OECD) countries when it comes to overall capital cost recovery on business investment.

And when publishing the call for evidence, the government stated that: “According to OECD data, companies invest just 10% of GDP each year, compared with 14% in our competitor countries—our tax system doesn’t reward investment as much as other countries do.”

However, it seems we should not expect the UK to be moving up this OECD table much after 2023. The Chancellor’s “Tax Plan,” published alongside the Spring Statement, says: “The challenge now is to find the most effective way to cut taxes on investment while ensuring value for the taxpayer.”

Similarly, the main document makes clear that the super-deduction is expected to cost 10 billion pounds a year to the Treasury and goes on to talk about prioritizing improvements to capital allowances in “…the areas that have the biggest impact, to ensure the UK tax system is more effective at driving growth.”

To put it crudely, the Chancellor wants the biggest possible bank for his buck from 2023 onward.

What Options Are Under Review?

The Spring Statement and call for evidence list a number of potential changes that the government could make to encourage business investment in plant and machinery including:

• Increase the permanent level of the AIA, for example to 500,000 pounds. The permanent level of the AIA was 200,000 pounds per annum, although this has been at 1 million pounds per annum since January 1, 2019 and was extended temporarily in Budget 2021 to March 31, 2023.
• Increase writing down allowances for main pool and special rate assets from their current levels of 18% and 6%, to 20% and 8%. This would particularly support those investing above the permanent AIA level.
• Introduce a first-year allowance for main and special rate assets where firms can deduct, for example, 40% and 13% in the first year, with the remaining expenditure written down at standard writing down allowances. Again, this would support those investing above the permanent AIA level.
• Introduce an additional first-year allowance, to bring the overall amount that can be claimed to greater than 100% of the initial cost. An additional capital allowance of 20% in the first year, on top of standard writing down allowances on 100% of the initial cost across the first and subsequent years would spread relief over time, while giving relief on over 100% of the initial capital cost.
• Introduce full expensing, to allow businesses to write off the costs of qualifying investment on plant and machinery in one go. No other country in the G-7 has implemented this on a permanent basis. While this measure would clearly be attractive and have the significant benefit of simplicity, full expensing of plant and machinery could cost significantly more than the above options—up to 11 billion pounds a year according to the Treasury (even higher if full expensing was also extended to special rate pool assets). So, understandably, the call for evidence seeks views on whether it would be well targeted to achieve more overall investment than specific capital allowances or even non-tax options (one assumes, grants, etc). The Treasury is concerned that full expensing “risks incentivising inefficient, low-return debt-financed investment.” Concerns about potential abuse are also raised.

At time of the Spring Statement, I had mentally marked this option down as an “outside bet” at most, but the call for evidence also says “the government welcomes views on how best to target our approach if less funding is available.” This may open the door to effective full expensing for small and medium-sized enterprises by increasing the AIA to, say, 5 million pounds on a permanent basis—the sort of measure that BDO, and business organizations, have campaigned for in recent years.

The Spring Statement acknowledged that the government could also consider changes to other allowances, such as the structures and buildings allowance, or new reliefs targeted at specific investments, such as the current enhanced capital allowances within designated Freeport areas. I would not be surprised to see the return of enterprise zones in some form to help support the government’s leveling up agenda.

There might also be a need for heavyweight allowances to support the government’s carbon-neutral agenda—particularly related to buildings and other long-term infrastructure. For example, a green buildings allowance that enabled 20% relief on costs of carbon-neutral commercial buildings every year for 10 years could be a game changer for businesses and help to achieve the step change in energy use that is needed to meet the government’s CO2 targets.

What Happens Next?

The call for evidence closes on July 1, and the Chancellor is expected to announce his preferred options in the autumn budget.

Those with a good memory will no doubt remember that, under previous Chancellors, we have been through a number of detailed and lengthy consultations to radically reform the existing UK capital allowances system, including abolishing the existing regime and replacing it with a tax depreciation system aligned with the accounting depreciation. Each time, the outcome of these consultations was to retain the existing system.

Based on this government’s announcements about this review and the short timeline for responding to the call for evidence, it seems likely that any changes in 2023 will, yet again, simply look to enhance the existing rules through changes in rates or by utilizing first-year allowances to encourage investment in specific areas.

Missing an Opportunity?

Every UK Chancellor wants to be seen to help boost business investment, so there is a long history to tweaks and time-limited changes to the UK’s capital allowances rules. Whether any changes to capital allowance announced in the next budget will add up to their billing of “reform” (given in the Chancellor’s Tax Plan) remains to be seen.

The problem is that adding new first-year allowances or time limited special rates of relief, rather than smoothing out dips in investment, may equally contribute to a cycle of boom and bust in capital investments. While the super-deduction was much needed at the time of introduction, I suspect it will lead to a short-term boom in investment over the next nine months.

The Treasury has effectively acknowledged this by launching this review, and asks for detailed feedback on how it has influenced investment behavior. If it has triggered a boom in overall investment, the key task for the Chancellor now is to make changes that will stave off the inevitable bust that would otherwise occur in 2023-24.

Of course, common sense would suggest that uncertainty over future tax relief is not a good base on which to plan long-term capital investment for your business. The key reason that the Tax Foundation, along with many other business groups (and myself), would like to see specific capital allowances (and potentially full expensing) made permanent is to give business certainty. While this does not make for good Budget Day headlines, it would be better for the economy.

The Chancellor should recognize that he is not going to change the long-term cautious mindset for business investment in the UK without some major change in the tax landscape: If the government wants business to take bold investment decisions in the future, it will need to take some bold steps of its own. Introducing the super-deduction was certainly an innovative solution, but moving the goalposts again next year just takes us backwards.

A truly bold step would be to create a beneficial capital allowances regime that is guaranteed for the long term—for example, by having a rule that no newly created capital allowance should last less than 10 years, with at least five years’ notice being given before it is withdrawn or rates of relief changed.

How Should Businesses React?

In the short term, there may be a compelling financial case for investing to take advantage of the super-deduction while you can and before inflation really adds to the cost of the investment you want to make. For 2023-24 onward, the position will be harder to judge, at least until the budget announcements.

Even without significant new allowances, the higher corporate taxes on profits may make capital investment seem as attractive numerically as under the super-deduction, yet the wider economic picture may encourage caution. Cynics may even point to the fact that economic downturns tend to lead to the emergence of attractive tax breaks created by worried politicians—so it might just be wise to hold off until the cycle starts again!

On a more positive note, I would encourage all UK businesses of all sizes to take part in the call for evidence and to push the government to create a beneficial tax regime for encouraging capital investment in the UK that is fixed for the long term to support investment decisions. If the Chancellor wants businesses to invest boldly, he will have to be bold too.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners. 

Author Information

Steve Watts is a tax partner at BDO.

The author may be contacted at: steve.watts@bdo.co.uk