Capital allowances reform - a green opportunity?

The UK Government plans to make changes to the capital allowances regime to better support UK business investment. In doing so, it feels like now is the right time to align this to the environmental, social and corporate governance (ESG) agenda and the collective focus on Net Zero. From speaking to our clients in the context of the capital allowances consultation for change, we have identified a clear appetite to incentivise sustainable, green investment for their businesses. And consequently, an opportunity for the UK Government to consider measures that would encourage companies across all sectors to invest in energy-efficient plant machinery and increase investment in green technology from UK and overseas investors.

Choosing greener options for technology, materials or other assets as part UK business investment plans can be more expensive than alternatives which do not deliver the same benefits. As such, UK businesses may have no immediate benefit (from a purely financial perspective) to align to the ESG and Net Zero agenda. Capital allowance reform could give tax incentives to countervail the extra expenditure, increasing the focus on ‘green’ investments.

The pace of change

PwC recently carried out a survey in which we explored the potential for the capital allowance regime to be augmented and modernised to ensure it is well targeted, competitive and effective. We provided commentary on the key findings in our previous article. An appropriate regime would contribute to achieving the Government’s goal of supporting business investment through fostering a new culture of enterprise and growth in the UK, as well as supporting the transition to Net Zero.

A recent capital allowances survey of our clients revealed 89% of businesses believe green incentives will stimulate investment given that it would provide additional/accelerated tax relief. However, companies were split on how this scenario could be realised. The survey also revealed that companies thought this would best be achieved by implementing a criteria-based regime. Specific grants to install or develop green-credentialed assets while permitting capital allowances to be claimed was the option of choice for 30% of businesses, with another 26% opting for an approved list of green assets that would receive additional capital allowances. Only 7% indicated there was no need for special green incentive schemes.

Due to the nature of investment decisions, designing green energy relief would also be best geared towards simplicity and long-term availability, so that as many businesses as possible can realise the tax benefit of making decisions that put people, and the planet - first.

In designing the right incentives, it’s worth noting that what is considered energy-efficient today, may not be viewed as such in five or 10 years’ time. New technologies move at a rapid pace, therefore it's important to ensure any plans drawn-up take this into account. It also takes time for taxpayers to fully understand how a given regime works, and this is before further time considerations come into play, such as lead-times for buying energy-efficient equipment, raising finance and drawing-up project plans. This consideration is particularly relevant for infrastructure projects and businesses venturing into ‘green’ initiatives that work over longer timeframes. Some of our clients stated the two-year super-deduction window was a limiting factor in their ability to access relief, and feel extending the window would go some way to enabling them to benefit from the 130% deduction.

It’s also important that any reforms are not so prescriptive that they unwillingly exclude initiatives which would have a material long-term impact on the UK economy, and lead to positive environmental and social change. We saw from the abolished Enhanced Capital Allowances scheme (energy efficient and water saving technologies providing 100% first year tax deduction), that firms considered it difficult to navigate. This difficulty led to a relatively low uptake and ultimate repeal of the scheme, and as such meant that companies did not necessarily focus on investing in green assets. Through simplification, there is an opportunity to increase this uptake with any future measures. Our experience tells us taxpayers and our clients are looking for a stable regime that allows them to invest in the short, medium and long term with certainty.

Building on the success of the super-deduction

The results from our survey, along with the work we have undertaken with clients, indicates the super-deduction regime has been successful, in that businesses are seeking to invest and accelerate their capital programmes. It has helped place a spotlight on investment decisions in 2021-23. 46% of businesses with turnover in excess of £500m say that the super-deduction has brought forward their investment decisions. Extending the window beyond its current two-year timeframe could realise far greater benefit for the UK from the infrastructure sector. Many organisations working in this sector operate to five or 10-year lead times.

As well as making changes to existing legislation, there is a further opportunity to consider targeted tax relief for certain asset-classes or qualifying criteria, such as carbon-reducing energy generating plant and machinery. Another idea is to implement a special regime similar to the Freeports model, which offers tax relief to promote regeneration and innovation through the lense of ‘green‘ investments. This would not only align to the UK Government's strategy of ‘levelling up’ (which is the aim of Freeports) but would also help businesses advance towards Net Zero goals, which again aligns with the UK Government's strategy.

An example of how a targeted regime could work is the recent US Clean Energy for America Act. The Act includes new tax incentives for clean energy companies, including electric vehicles and advanced manufacturing, with at least 10 years of tax incentives for clean electricity generation. The Act addresses the issues with large, complex green projects that can span multiple periods, by giving certainty around the tax incentives available. It will be interesting to see what impact the Act has in the coming years on the US aims to reduce carbon emissions by roughly 40 percent by 2030.  

Encouraging ‘green’ decisions for all

Incentivising renovations and reuse (by providing a full tax deduction for revenue expenditure/repairs costs, that have been capitalised in the accounts if taken in the year of expenditure), is another way to encourage businesses to make the best use of existing assets, and push for more sustainable investments.

Furthermore, introducing tax credits to ensure that loss-making businesses obtain some tangible benefit should help increase ‘green’ investments. This approach would also open up opportunities for new companies across the board to ingrain sustainable decision-making within their business.

As mentioned, 30% of organisations we surveyed indicated that specific grants to install/ develop green credentialed assets, whilst also enabling capital allowances to be claimed, would incentivise investment in green assets with a further 26% indicating that a prescribed list of approved green assets that attract capital allowances would further stimulate investment.  

Certainty is key

This desire for certainty on the UK Capital Allowances regime amongst those surveyed including ‘green’ capital allowances is applicable across all asset classes. Whether it's linked specifically to the pressures and challenges around transitioning to ‘green’ energy, (e.g. from fossil fuels into biomass or offshore wind), energy challenges and environmental concerns run through every aspect of the UK business landscape,from manufacturers and energy companies to retailers and hotels to public sector organisations.

What’s next?

We expect the changes to the Capital Allowances regime to be announced in the short to medium term. In the meantime, PwC will continue to engage with stakeholders to help build clarity on what the new landscape for capital allowances could look like and how green investment could be enhanced.

If you would like to discuss the current regime or the proposed changes, please get in touch with Phil Sullivan, Ashley Austin or your usual PwC contact.