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Business Tax Reform – Winners & Losers
(being published in April edition of AccountingWeb)

John Kinsella , Tax Partner at MGI Watson Buckle  discusses the winners and losers in the new business tax reforms.

On 17 December 2007, the government published two key technical notes.  The first on the capital allowance changes proposed in the Business Tax Reform announced in the 2007 Budget and the second on the new ECA tax credit.  Both of these were following consultation periods following the draft proposals in July.

The proposed Capital Allowances changes are the latest in a long series of tinkering in this area that seems to have been proposed discussed, reviewed and consulted on for as long as I can remember.  We now seem to be at the closing stages of this process, or at least one would certainly hope so as there will shortly be thirteen different types or rates of relief for capital expenditure for taxpayers to consider which excludes the industrial buildings allowances, hotel building allowances and enterprise zone allowances that are currently being withdrawn.

The stated objectives of these reforms were to promote investment and growth, reduce administrative burdens and complexity and to maintain the fairness of the tax system.   Whether this is being achieved depends on where you are sitting but there are clearly a number of winners and losers in this process. 

The government has tried to point out that the tax burden will be neutral to the economy with the decrease in corporation tax and the decrease in tax relief cancelling each other out, but what we are seeing is that where previously the relief’s were targeted to specific industry groups to promote investment where it was most needed, the view is now to ignore industry differentials under the banner of simplification.

Sitting in the “I’m all right Jack” camp will be the large corporate occupiers who have the benefit of the reduced corporation tax rate the extension of the plant and machinery allowances to assets not previously included (that I will come on to) and the increased availability of the enhanced capital allowances scheme.  Indeed the large property companies should be feeling quite comfortable as they typically have an economic cycle of twenty years or more and a relatively slow asset turnover so the 10% rate of relief is reasonably suited to such a business model and they have the added opportunity of converting to a REIT if they haven’t already done so.

Not so good for the retailers though whose investments have a shorter economic cycle, with many branches being refitted every four to five years and much of this expenditure will be caught by the Integral features legislation.  The proposed allowance will reduce the tax depreciation to a level which is by no means comparable to the commercial and economic reality.  Furthermore the proposed legislation excludes integral features from being treated as a short life asset so there is no escape!

Even worse for the, transport sector, the hotels and the manufacturing sector which is still reeling from the loss of industrial buildings allowances which is not nearly compensated for by the reduction of corporation tax.  However, it would appear from the way the legislation is drafted that the utilities companies will be the biggest losers. They not only lose the IBA’s and have to deal with the plant and machinery pool dropping from 25% to 20% tax relief per annum, but also potentially have the majority of their plant and machinery expenditure being re-categorised to integral features and having the rate of relief further reduced to 10% p.a.

Turning to the practicalities of these changes the key areas of change are around the proposed

• Integral features
• Annual Investment Allowance (AIA) and the
• Payable Enhanced Capital Allowances Credit

Integral Features

The integral features legislation will have the effect of creating a new pool of plant and machinery allowances with the rate of relief reduced from 25% to 10% on a reducing balance basis.  This is on the back of changes to the general plant and machinery pool which will be reduced to 20% and the long life asset pool which will be increased from 6% to 10%. 

Following the consultation it has been decided that integral features should be identified through the use of a short defined list rather than a definition based on the expected purpose of the asset.  I agree that this approach will have a better chance of success of being understood and implemented in a prescribed manner, but it lacks focus on the trades that need the relief most.

The proposed list of “integral features” is as follows:

• Electrical systems
• Cold water systems
• Space or water heating systems, powered systems of ventilation, air cooling or air purification, and any floor or ceiling comprised in such systems
• Lifts, escalators and moving walkways
• External solar shading
• Active facades

So where previously only certain taxpayers have had a higher rate of relief on parts of say the electrical system cost, now all taxpayers will have a lower rate of relief on all of the cost.  The introduction of relief on external solar shading otherwise known as brise soleil and active facades is an interesting introduction, as these assets were not previously included at all as they would have been part of the building structure.  This is a step in the right direction for promoting the passive elements of “green design” within buildings as these assets work to reduce the energy consumption within buildings.

As many of these rate changes will be introduced for years ended post 1April 2008 companies need to be ready to incorporate the rate changes.  The draft legislation has opted to time apportion the rates so for a June year end the plant and machinery pool will have a transitional rate of 9 months at 25% and 3 months at 20% giving the transitional period rate of 23.75%.  Expenditure on integral features however will need identifying based on when it is incurred post 1 April 2008 for corporates, which will pose some complications for construction projects that span this date.

AIA

The Annual Investment Allowance provides an annual 100% allowance for the first £50,000 of investment in plant and machinery (except cars) to all businesses.  This will help small businesses but is being offset by the withdrawal of first year allowances for small and medium firms.

One concession is that the proposed legislation will allow the AIA to be allocated against any pool of qualifying expenditure and therefore can be offset against the lower rates of relief in the form of Long life assets and integral features to preserve the higher 20% and 100% relief’s which will provide a NBV benefit.

This may also help many small firms administratively as it will mean there is no need for the long life asset or integral features pools and there will be no need to transfer assets from the FYA pool to the general plant and machinery pool.

Payable Enhanced Capital Allowances

The HMT Technical note on payable ECAs encompasses the introduction of a payable credit for loss-making companies incurring qualifying expenditure on or after 1 April 2008.  This is an important revision as it shouldn’t just be profitable companies that are encouraged to invest in environmentally friendly assets.

The proposed tax credit rate will be 19% of the loss which is surrendered and there will be a limit to the amount of tax credit a company can claim, to equal the higher of:

• the value of the company’s PAYE and NI liabilities for payment periods ending in the chargeable period for which the claim has been made; and
• £250,000 credit (i.e. £1,315,789 loss surrendered)
  

The implementation of a cap on payments by company is a sensible measure for the protection of the Exchequer and I do not see any obvious problems with a capping mechanism similar to that in place for payable R&D credits.  However restricting the availability of payable ECAs to companies only seems unnecessary and it should be extended to individuals and partnerships.

Claims for ECA payments will be submitted through company tax returns, with the amount of loss being surrendered being clearly identified.   There is also an additional issue concerning the clawback of payments where an asset on which an ECA tax credit is claimed is sold within 4 years.  A company can however retain its tax credit to the extent that it has made a loss on disposal.   Where losses are clawed back the surrendered losses will be restored to the company so that it reverts to the position it would have been in if losses had not been surrendered.  So quite a lot of admin to consider, especially for a scheme that has little take up due to the administrative burden it requires.

The hierarchy of capital expenditure relief:

LRR	–	150%
AIA	–	100%
BPR	–	100%
FCA	–	100%
ECA	–	100%
ECA credit
R&D	–	100%
SLA	–	33%
P&M	–	20%
MEA’s	–	20%
P&M Integral	–	10%
LLA	–	10%
Deferred Revenue	–	variable