Super-deduction cash savings ends in 12 months

Super-deduction Cash Savings Ends in 12 Months:

A review of the Benefit and What is Next in Store

Written by

M O’Ikenegbu

April 2022

Introduction

The super-deduction scheme introduced in Finance Bill 2021 to amend Part 2 Capital Allowances Act 2001, is a two-year temporary first year allowances (FYA)[1] for certain qualifying capital assets in the form of plant and machinery.

Considering that it is just 12-months to the end of the super-deduction scheme introduced by the Chancellor of the Exchequer, The RT Hon Rishi Sunak MP during his 2021 spring statement, this article discusses the need to maximise the cash saving opportunities that the scheme presents, before the curtain is drawn. This article also explores similar measures that may be introduced to continue to make capital allowances more lucrative to businesses which pay tax in the UK.

This article will be particularly useful to those in finance and capital decision making roles, or businesses planning a capital project or property acquisition.

Super-deduction as a form of capital allowances

As the super-deduction scheme is a form of capital allowances tax relief, let us first look at what capital allowances is briefly. This will set the scene and provide the relevant background to appreciate the value and structure of the super-deduction.

Depreciation of fixed assets charged in the accounts is not allowable in computing taxable profits. Instead, the UK government introduced capital allowances which is a form of tax relief that allows businesses which pay tax in the UK to deduct from their taxable profit (before calculating their tax liability), the value of their qualifying capital expenditure on assets such as equipment or buildings.

Capital allowances comprises of various forms, types and categories of which the most common is plant and machinery allowances (PMA) which is a type of capital allowances that provides tax relief on capital assets such as business equipment qualifying as plant and machinery.

What is super-deduction?

The super-deduction scheme introduced in Finance Bill 2021 to amend Part 2 Capital Allowances Act 2001, is a two-year temporary first year allowances (FYA) for certain qualifying capital assets in the form of plant and machinery. The scheme was announced on 03 March 2021 and is only available to businesses within the charge to Corporation Tax. The scheme took effect from 1 April 2021 and will cease to be available on 31 March 2023. It however excludes contracts/agreement for specific cost items entered into prior to the announcement on 03 March 2021.

Benefit of the scheme

The super-deduction provides 130% first year deduction in respect of qualifying main pool items. Without any upper limit on the level of spend.

Alongside the 130% super-deduction on main pool items, the government additionally allows 50% first-year deduction in respect of special rate pool items. This 50% deduction is therefore known as special rate (SR) allowances.

Restrictions

Aside the requirement that in order to qualify for super-deduction, the contract/agreement for the asset must be entered into prior to 03 March 2021, the date of unconditional obligation to pay should also be such that the capital expenditure incurred falls between the start of the scheme on 1 April 2021 and the end on 31 March 2023.

The super-deduction is subject to anti-avoidance provisions as well as the usual FYA general exclusions including restrictions on second-hand assets and expenditure for the purpose of leasing. Following an amendment to the original structure of the scheme, the restriction on assets purchased for leasing no longer includes background plant and machinery in buildings. This is particularly of interest to landlords incurring costs on fixtures such as lifts. Also, assets used within a ring-fence trade in the oil and gas sector are excluded.

Additionally, there is a distinction between assets for leasing and assets for the provision of services. For example, the former may relate to a standalone construction plant hire, whilst the latter may relate to the supply of not just the construction plant, but the operator as well to attend and run the plant.

Worked example

As an example, a company incurred capital expenditure of £11m (excluding land) in constructing a new office during the accounting period ending 31 March 2023. The company also made a profit of £10m within that accounting period.

The £11m development cost incurred includes £2m of main pool qualifying items and £1m of special rate pool qualifying items, whilst the £8m remaining costs is in respect of structural and related building elements.

Scenario 1 – Utilising super-deduction

During the accounting period ending 31 March 2023, the company will be able to claim super-deduction and SR allowances as follows:

£2m of main pool qualifying items will result in £2.6m deductible from the company’s profit in that accounting period. Assuming 19% Corporation Tax rate, this equates to tax cash saving of £494,000 (24%).
£1m of special rate pool qualifying items will result in £500,000 deductible from the company’s profit in that accounting period. Assuming 19% Corporation Tax rate, this equates to tax cash saving of £95,000 (9.5%).
The remaining 50% of the £1m of special rate pool qualifying items (£500,000) may be deducted under annual investment allowances (AIA)[2]. Assuming 19% Corporation Tax rate, this equates to another tax cash saving of £95,000.

The company will therefore be entitled to a total tax cash saving benefit of £654,000 all available straightaway.

Although not covered within the scope of this article, additional tax relief may be available in respect of the £8m of structural and building related elements, through another type of capital allowances known as structures and buildings allowances (SBA).

Scenario 2 – Assuming super-deduction is not available

During the accounting period ending 31 March 2023, the company may be able to claim only AIA and writing down allowances (WDA)[3] as follows:

£2m of main pool qualifying items will result in £68,400 ([£2m x 18% MP rate] x 19% Corporation Tax rate).
£1m of special rate pool qualifying items will result in £190,000 (£1m x 19% Corporation Tax rate) if claimed in full through AIA.

The company will therefore be entitled to a tax cash saving benefit of £258,400 available straightaway.

Additional allowances in respect of the main pool qualifying items will subsequently be claimable by the company annually at a reducing balance basis. Like in scenario 1, additional tax relief may also be available through SBA, in respect of the £8m of structural and building related elements.

Summary

With the super-deduction, the company may be entitled to a total tax cash saving benefit of £654,000 all available straightaway. This is a better outcome compared to the expected result of £258,400, had super-deduction not been available.

Other considerations

Due to restriction to only companies subject to Corporation Tax, partnerships may see the super-deduction as an incentive to structure their imminent capital project under the incorporated entity partner. Likewise, business groups may choose to structure their capital projects under their trading entity rather than through their propco. It is therefore important to take into account factors such as the specific circumstances of the business, anti-avoidance provisions, impact of losses and future disposal.

Apportionment of the allowances will be required in respect of accounting periods that straddle the start or end date of the super-deduction. For instance, in an accounting period ending 31 December 2023, a company incurs £1m of super-deduction qualifying expenditure on 1 March 2023. The super-deduction will not be £1.3m (£1m x 130%), rather it will be £1.074m (£1m x 107.4%). The adjusted percentage is based on 30 x (90 days before end date ÷ 365 days in the year) + 100.

If claiming super-deduction puts a company in a loss-making position for tax purposes, or if it increases existing losses, a carry back of the losses to a prior profitable period may be possible. This may result in a tax refund due to overpayment in that prior period. A carry forward of losses to reduce tax liability in a future profitable period may also be possible subject to loss restrictions.

Additional considerations need to be made in relation to disposal of the asset in respect of which super-deduction has been claimed. It is expected that a balancing charge will arise when the asset is disposed. The calculation of the balancing charge which must be added to the taxable profit of the claimant is dependent on whether the disposal of the asset and the relevant accounting period was before or after 1 April 2023 (after the super-deduction has ended). The calculation also takes into account certain variables such as relevant proportion between super-deduction expenditure and total plant and machinery expenditure, as well as relevant ‘adjustment’ factor. For instance, in an accounting period ending 31 March 2022, a company incurs £1m of qualifying expenditure in respect of which super-deduction was claimed. The asset was subsequently disposed on 1 March 2023. The balancing charge will be £1.3m ([£1m x relevant proportion (i.e., £1m/£1m)] x 1.3 relevant ‘adjustment’ factor of 1.3).

Impact of the Spring Statement 2022

The Chancellor Rishi Sunak on 23 March 2022 delivered his Spring Statement 2022 speech at the house of commons. Based on his speech, it would appear as though the government has no intention to extend the super-deduction scheme beyond its planned end date of 31 March 2023. However, come April 2023, it is expected that a number of reforms to better support business investment in the UK would be coming into effect.

The full Spring Statement 2022 document does not contain details of any confirmed concrete changes. However, some of the reforms the government is considering include a very ambitious 100% capital expenditure deduction from taxable profit, otherwise known as full expensing. In modern British history, this is considered very generous and simplified. This could potentially mean that when a business spends a £1m in acquiring any piece of plant or apparatus for carrying on their business activity for example, they may be entitled to deduct the £1m immediately in full from their taxable profit in that year. Assuming a 25% Corporation Tax rate, the immediate tax cash saving benefit would equate to £250,000. This is far more generous than the immediate tax benefit expected in the current tax relief landscape (excluding the temporary super-deduction).

There are other changes the government is also considering which may not be as generous, and have the potential to further heighten the complexity of the capital allowances scheme. They include increasing the annual investment allowances permanent limit from £200,000 to £500,000. This is currently set at £1m temporarily until 31 March 2023. The main and special deduction rates of writing down allowances (WDA) which is more or less the default avenue of getting tax relief on plant and machinery allowances, could also be increased from 18% and 6% respectively, to 20% and 8%. The government is also considering a new first-year allowances scheme that will see for example 40% and 13% of immediate deduction available on main and special rate pool qualifying assets respectively. The balance of say 60% and 87% will then be available in the default way through the WDA. There is yet another variation of the first-year allowances which the government is also considering. This will be in addition to claiming the default WDA. For instance, in addition to eligibility to claim WDA on £1m of qualifying capital expenditure, an additional 20% of allowances, that is £200,000 may be claimable in the first year. That means that an overall allowances of £1.2m or £300,000 of tax cash saving benefit (assuming 25% Corporation Tax rate) will be claimable, albeit over a number of years. This has some similarities to the super-deduction scheme; however, the 130% super-deduction is designed to be claimable in full immediately.

Further to this, Her Majesty’s Treasury has released on 9 May 2022, a policy paper on the potential reforms to the UK’s capital allowances regime. The publication is aimed at kickstarting a conversation with businesses about how to reform the UK’s capital allowances regime. Ahead of the Budget later this year, it is important for businesses and stakeholders to participate in that conversation, by responding to Her Majesty’s Treasury’s “Potential Reforms to UK’s Capital Allowance Regime” survey, by 5pm on Friday 1 July. The survey focuses on certain areas of interest such as, evidence on the impact of capital allowances on capital investment decisions, evidence on the impact of the super-deduction on investment decision making; as well as views on the current system of capital allowances and how it can be improved.

What’s next?

The super-deduction ending on 31 March 2023 provides 24.7% tax cash benefit based on the current 19% Corporation Tax rate. Furthermore, the new 25% Corporation Tax rate kicking in on 1 April 2023 will provide 25% tax cash saving benefit. As both tax cash benefits are more or less the same, it would appear as though the government has no intention to extend the super-deduction scheme beyond its planned end date.

If the scheme was to be extended, that would mean the majority of companies subject to the 25% Corporation Tax rate will be receiving tax cash saving benefit of 32.5%. This would be welcomed by businesses and would likely boost the “Covid or post-Covid economy”, albeit costing the government billions of pounds. Assuming the scheme will not be extended, it would not be surprising to see that the government will introduce another measure that will be equally beneficial. This is very likely considering that the government is planning to boost the economy through tax reforms that incentivise business investment. This is in fact, the first of three key priorities aimed at economic growth in the UK through fostering a new culture of enterprise.

Recently at the annual Mais lecture held at the Bayes Business School on 24 February 2022, the Chancellor Rishi Sunak, explained the three key priorities – “Capital. People. Ideas.” [4] He mentioned that “capital investment by UK businesses averages just 10% of GDP, considerably lower than the current OECD (Organisation for Economic Co-operation and Development) average of 14%”.

In his Spring Statement 2022, the Chancellor also alluded to the fact that, when compared with other countries, the tax treatment allowable in the UK for capital assets such as those qualifying as plant and machinery is much less generous that the OECD average. As a result, the Chancellor hinted on prioritising cutting taxes on business investment. Some of the changes the Chancellor is considering can be considered very ambitious but attractive to businesses. In any case, it is hoped that the new reforms that will come into effect in due course will boost and incentivise business investment to unprecedented levels.

Another new capital allowances measure which the government could consider may relate to a robust replacement of the now repealed Enhanced Capital Allowances (ECA) scheme on energy and water efficient assets. This could potentially be well received by businesses. The new measure is on the premise of the government’s efforts towards environmentally friendly assets, and a green / sustainable future, in order to decarbonise all sectors of the UK economy[5]. This includes the government’s heat and buildings (net zero) strategy which includes commercial and industrial properties[6]. This ambitious net zero (emissions by 2050) strategy of the government, including setting out how the UK will unlock £90 billion in investment in 2030 is a good backdrop for such a new energy incentive capital allowances scheme[7].

In the meantime, these new measures do not imply deferring planned investment in capital assets, however, it draws attention to the need to maximise the cash saving opportunity available with the super-deduction whilst there is still time, in readiness to then take advantage of additional tax relief that is expected to be announced by the government in due course.

Conclusion

In summary, the tax cash saving benefit of super-deduction means that businesses have a really good incentive to go ahead with, or bring forward their capex projects within the next 12 months.

If the scheme is not extended, it would not be surprising to see that the government will introduce another measure that will be equally beneficial. This is very likely considering that the government is planning to boost the economy through tax reforms that incentivise business investment. It is interesting to see the array of reforms to the capital expenditure tax relief landscape, which the government is considering as featured in the Spring Statement 2022. This includes the ambitious full expense of qualifying investments at one go.

In the meantime, it is important to maximise the cash saving opportunity available with the super-deduction whilst there is still the time. Thereafter, prepare to take advantage of additional tax relief expected to be announced by the government in the due course in the Autumn budget and beyond, as hinted by the chancellor during his recent Spring Statement 2022 speech.

Ahead of the Budget later this year, it is also important for businesses and stakeholders to participate in the government’s review aimed at new reforms to the capital allowances regime, in order to best support business investment. This can be done by responding to Her Majesty’s Treasury’s “Potential Reforms to UK’s Capital Allowance Regime” survey by 5pm on Friday 1 July.

The content of this article is based on the understanding of the capital allowances legislation and HMRC guidance in existence at the time of writing it.

[1] First-year allowances (FYA) allow a full deduction of the costs incurred on certain qualifying capital assets in the form of plant and machinery, during the (first) year the spend was incurred. Hence it is called “first year” allowances.

[2] Annual investment allowances (AIA) allow a full deduction up to a certain annual limit in respect of the costs incurred on certain qualifying capital assets in the form of plant and machinery, during the year the spend was incurred. The current annual limit is £1m.

[3] Writing down allowances (WDA) allows tax deduction at a reducing balance basis. The WDA has two pools or rates which includes the main pool (MP) rate of 18% on assets such as business equipment and furniture. There is also the special rate pool (SRP) of 6% on assets such as heating, ventilation, and air-conditioning systems.

[4] https://www.gov.uk/government/speeches/chancellor-rishi-sunaks-mais-lecture-2022

[5] Net Zero Strategy: Build Back Greener, 2021; https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1033990/net-zero-strategy-beis.pdf

[6] Heat and buildings Strategy, 2021; https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1044598/6.7408_BEIS_Clean_Heat_Heat___Buildings_Strategy_Stage_2_v5_WEB.pdf

[7] https://www.gov.uk/government/news/uks-path-to-net-zero-set-out-in-landmark-strategy#:~:text=A%20landmark%20Net%20Zero%20Strategy,government%20today%20(19%20October).