As an incentive for businesses to invest in energy-saving equipment, enhanced capital allowances are available for expenditure on qualifying energy-saving plant or machinery. These enable businesses to claim a 100 per cent first-year allowance on such expenditure. A tax credit is also available for loss-making companies for similar expenditure. The energy-saving equipment scheme applies to industries including the electricity sector such as Combined Heat and Power, and the water sector, such as Water Reuse. Under a separate scheme, 100 per cent first-year capital allowances are also available for certain expenditure by a business on equipment that it supplies to others as part of providing energy management services.
How capital allowances work
What is a capital allowance?
When a company buys a capital asset, it cannot deduct its expenditure as an expense when working out its trading profits for tax. This can cause a cash flow problem for companies that need to invest in capital equipment for their trade. Capital allowances ease this problem for certain assets by enabling a company to deduct a proportion or the whole of its expenditure on the asset in the calculation of the profits on which it pays tax.
What size of capital allowance is available?
The rate of the capital allowance available depends on the nature of the asset. Subject to the general rules on entitlement, qualifying expenditure on plant or machinery will attract a 20 per cent writing-down allowance. Long-life assets (which are broadly those with a useful economic life of more than 25 years) attract a 10 per cent allowance.
An annual investment allowance is generally available to all companies for the first £50,000 of expenditure in any year on plant or machinery. This means that this expenditure can be deducted from the company’s taxable profits for the accounting period in which the expenditure was incurred, as long as the company owned the assets at some time during that period. Groups of companies only get a single annual investment allowance of £50,000. The annual investment allowance was introduced in April 2008.
In addition, in the 2009 Budget the Chancellor introduced a temporary first-year allowance for general plant or machinery. This will enable businesses to deduct 40 per cent of their expenditure incurred in the 12-month period beginning on 1 April 2009 for corporation tax (or 6 April 2009 for income tax).
Various capital allowance schemes have been set up to encourage companies to invest in particular assets or activities. These include schemes relating to investment by businesses in “environmentally beneficial plant or machinery” and expenditure incurred by business to provide energy-efficient equipment to others as part of energy management services.
Those schemes make enhanced capital allowances available for qualifying expenditure, so that if the conditions of the scheme are met, the business can deduct 100 per cent of its expenditure in the calculation of its trading profits in the year in which the expenditure is incurred.
Enhanced capital allowances for expenditure on environmentally beneficial plant and machinery
100 per cent first-year allowances are available to businesses of any size for their expenditure on designated energy-saving plant and machinery and water-efficient plant and machinery.
The plant and machinery items that qualify for the enhanced capital allowances are set out on lists of approved equipment.1 The appropriate list to consult will depend on whether the plant or machinery is “energysaving” or “water-efficient”. Manufacturers of plant and machinery may need to register their products on the relevant lists to make them eligible for the enhanced capital allowances.
“Energy-saving plant or machinery” is plant or machinery which is within a technology class set out in the Energy Technology Criteria List (e.g. Boiler Equipment, Combined Heat and Power, Compact Heat Exchangers and Pipework Insulators) and meets the criteria set out for that class. Certain types of plant or machinery must also be on the Energy Technology Product List (e.g. Biomass Boilers and all Compact Heat Exchangers). In some cases, such as Combined Heat and Power, a certificate of energy efficiency from the Secretary of State for each specific product will be needed for it to be eligible for an enhanced capital allowance. In the 2009 Budget, the Chancellor announced that one new technology class (uninterruptible power supplies) and two new sub-technologies (air to water heat pumps and close control air conditioning systems) will be introduced. Three existing sub-technologies (air source: single duct and packaged double duct heat pumps, ground source: brine to air heat pumps and water source: packaged heat pumps) will be removed. The updated list will be published later in 2009.
“Water-efficient plant or machinery” is plant or machinery which is within a technology class set out in the Water Technology Criteria List (e.g. Leakage Detection Equipment, Meters and Monitoring Equipment and Water Reuse) and meets the criteria set out for that class. Again, certain types of plant or machinery must be specifically listed on the Water Technology Product List (e.g. Remote Meter Reading and Leak Warning Devices, Flow Meters and Water Management Software). For these types of plant or machinery a certificate of environmental benefit from the Secretary of State must be in force.
In each case, the plant or machinery must be new and unused. It must not be a long-life asset, nor can it be leased, except in very restricted circumstances where it is a “functional” part of a leased building. The enhanced capital allowance is also available on direct costs of providing and installing the plant and machinery. Where one or more components of plant or machinery qualify as environmentally beneficial plant or machinery, the allowance will be given on the part of the expenditure that can be attributed to any qualifying component(s).
In addition, a payable tax credit was introduced, with effect for expenditure incurred on or after 1 April 2008, for losses resulting from expenditure on environmentally beneficial plant or machinery which would meet the conditions for an enhanced capital allowance as set out above. This will benefit loss-making companies, which were unable to take advantage of the availability of the enhanced first-year allowance. They will be able to surrender losses in relation to qualifying expenditure and will receive a tax credit (up to a maximum annual credit of the greater of £250,000 or the total amount of the company’s PAYE and National Insurance Contributions for that period). Where the plant or machinery in respect of which a credit has been paid is sold within four years of the end of the period for which the credit was paid, the credit will be clawed back.
Enhanced capital allowances for Energy Service Providers (ESPs)2
Where a business provides certain energy management services to its clients, it may incur expenditure on equipment which then becomes a fixture on the client’s land. The ESP may be entitled to be treated as the owner of the fixture for capital allowances purposes and to claim 100 per cent first-year capital allowances on its expenditure where it meets certain conditions in relation to the plant and machinery and the services that the ESP is providing.
Enhanced capital allowances may be available to someone who carries on a qualifying activity consisting wholly or mainly in the provision of energy management services to help other businesses reduce their energy needs and who enters into an agreement with their client, with a view to saving energy or using energy more efficiently, that provides for designing, obtaining, installing, operating or maintenance of plant or machinery. The ESP (or a person connected with it) must carry out the whole or a substantial part of the operation of the plant or machinery. The payments in respect of the operation of the plant or machinery must be linked to energy savings or increases in energy efficiency resulting from the provision or the operation of the plant or machinery.
The enhanced allowances become available to the ESP if:
- the plant or machinery is not provided for leasing;
- the plant or machinery is not provided for use in a dwelling house;
- the plant or machinery becomes a fixture on land in which the client has an interest but the ESP does not (e.g. the client owns the land into which the plant or machinery is installed by the ESP);
- the ESP and the client are not connected with each other (because the same person or persons control them both)3; and
- the ESP and the client notify HMRC that they wish to make an election for the ESP to be treated as the owner of the fixture from the time the ESP incurred the expenditure.
The allowance enables the ESP to claim any capital allowances the client would have been entitled to claim, as if the ESP owned the plant or machinery. If the plant or machinery falls within the Combined Heat and Power technology class, the ESP will be able to claim capital allowances even if the client would not have been eligible (e.g. if the client is a local authority and therefore outside the charge to tax).
Capital allowances in leasing
The availability of capital allowances may be particularly important in the context of leasing.
The type of lease and the nature of the assets will determine whether the lessee or lessor will be able to claim capital allowances. In some cases, tax-structured leasing may be suitable for the acquisition or provision of the types of assets discussed in this guide, depending on the circumstances of the parties involved.