Capital Allowances and the OTS review - what you need to know now

Capital Allowances are a long-established and valuable form of tax relief for UK property investors. However, the current system is not without limitations.

January 08, 2020

Capital Allowances are a long-established and valuable form of tax relief for UK property investors. Current estimates put the tax saved this way at £21.5 billion for 2017/18.

However, the current system is not without limitations. The legislation is complex, creating additional compliance costs which, for some tax payers, are a barrier to maximising their entitlement.

So there’s no surprise that the Office of Tax Simplification (OTS) has consulted with the industry and stakeholders to inform its Capital Allowances simplification report, published June 2018.

What’s in the report?

At a high level, the OTS has been looking at the case for a depreciation system in place of capital allowances. To assess the case for or against change they have looked at:

  • The cost both to the Exchequer and the tax payer
  • Compliance hurdles
  • The perspective from the accounts and tax computation

Report conclusion: If it ain’t broke, don’t fix it

So why the review in the first place?

Again, we come back to the complexity and compliance costs.

Digging into the numbers reveals that of the £21.5 billion relief obtained, £2.5 billion is claimed through the Annual Investment Allowance (AIA). This currently covers the first £200,000 of annual investment in new qualifying business assets.

The OTS states that 98% of corporation tax payers make the relatively simple AIA claim. As a result, the OTS does not believe it is worth changing the whole system just for the remaining 2%.

A step in the right direction?

One immediate recommendation of the report, however, is to widen the scope of AIA to encompass all business assets, potentially paid for by reducing the annual allowance. This would cut the compliance burden on the majority of businesses claiming capital allowances and should be welcomed.

However, this is less than 12% of the total forecast value of allowances claimed in 2017/18. So is it enough to maintain the status quo? What about the remaining £19 billion in allowances?

Fear of complication

The OTS report rightly states that the transition process might outweigh the benefits of any change to a depreciation-based approach by being too lengthy and complex. However, OTS also concludes that it should be revisited, if the current regime cannot be simplified.

There would also be a need to protect Enhanced Capital Allowances (ECA) and Research and Development (R&D) tax relief if we went down the depreciation route. These reliefs are actively used to incentivise investment behaviour. This would all add complication.

Potential £7 billion loss to the Exchequer

The OTS also predict costs to the Exchequer under a change to depreciation.

They put this at £1 billion in year one, £6 billion in year 5 and rising to an eventual £7 billion per annum, a 32% increase over the current annual average.

So it seems likely that these additional Treasury costs — rather than the complexity — are the greater driver of the report’s recommendation to stay with the status quo.

Where do we go from here? 

With this report advocating the retention of the status quo, there is less pressure on the government to change the overall system. The OTS has left the door open where the current system cannot be simplified, which given its purpose, is an obvious statement to make.

We at JLL note with interest positive signs in the OTS report regarding three main issues:

  • Extension of the existing AIA
  • A widening of the scope of Capital Allowances to incorporate other assets for which there is currently no relief
  • Retention of the ECA and R&D tax reliefs

What about a solution that encourages energy efficiency?

This could be an area where the legislation can be simplified. We suggest the following:

Where an energy efficient refurbishment of an existing property improves the EPC rating of an existing property by 2 ratings or more, the entire cost of the mechanical and electrical installations could qualify for ECA relief.

Taking this approach would greatly simplify the compliance burden around ECAs, removing the existing ‘component by component’ rules. We believe this would encourage energy and water efficiency during the design and procurement phase of a project and greater improvement of existing property stock.

Get in touch

Having analysed the OTS report in detail the Capital Allowances team at JLL would be delighted to hear from you should you have any queries or need any advice.