Accounting depreciation v capital allowances – the results of the Office of Tax Simplification findings

The Office of Tax Simplification (OTS) has published its conclusions on whether the UK should adopt a system of accounting depreciation to simplify the granting of tax relief for tangible fixed asset investment. Should we be sticking with the devil everyone knows - capital allowances?

Here, our director Aubrey Calderwood sets out the OTS findings and shares his initial thoughts on what it all means.

Background: simplifying the regime

In July 2017, the OTS made a number of recommendations relating to the simplification of the UK capital allowances regime and stated that “further work needs to be done to explore more fully the impact of replacing capital allowances with accounts depreciation.”

The OTS launched a major consultation on 3 October 2017 taking in the views of a wide range of UK businesses and consultants specialising in this complex area. Gateley Capitus were one of the parties that the OTS met with and it was very interesting to hear the many views expressed at the meetings from different groups of taxpayers. 

However, for us, even at a very early stage, it was obvious that there was only ever going to be one outcome – at least for now: “The recommendation is that depreciation should not replace capital allowances and no further work should be done pursuing it at this time.”

The OTS went on to say: “If we were devising a system from scratch, depreciation could work perfectly well and would make eminent sense. However, our analysis has shown that the undoubted potential benefits are not worth the upheaval involved. Such an extension of the scope of relief would come with a big price tag, require lengthy transition periods, and involve all businesses in process change.

“That said, we consider there are important improvements to capital allowances which should be considered, alongside those we recommended in last year’s report, in particular that the scope of the Annual Investment Allowance be widened.”

One of the most welcome and, it has to be said, blindingly obvious statements in the report, was this: “Only one change will conclusively put a stop to interest in using depreciation: the radical simplification of CAs. Until and unless that is achieved the use of depreciation will always be raised as a potential route to overcome the scope restriction and the administrative burden of CAs.”

Time for a change!

 We have long since campaigned for a change in the complex rules relating to capital allowances, particularly in relation to buildings. Here are just a few areas that we have suggested should be changed.

Investing in new premises

It cannot be right, for example, that the tax relief given to the buyer of a building is completely dependent on whether or not a prior owner claimed capital allowances if they were entitled to do so. If that prior owner didn’t claim (and that could happen for myriad reasons) then tax relief is denied to the buyer of the building. That is simply unjust. There cannot be any other system in the world that denies tax relief to one taxpayer as a result of the inactions, lack of knowledge or just plain incompetence of another.

Investing in energy efficiency

When it comes to incentivising taxpayers to invest in energy or water efficient technologies through the Enhanced Capital Allowances (ECA) scheme, we find the system to be horrendously complex and burdensome. It is one which bears no relationship to how buildings are procured, constructed or costed and the level of information required to evidence a claim is virtually impossible to achieve for the average taxpayer. If the objective is to achieve more energy and water efficient buildings then we would advocate abolition of the current ECA scheme and replace it with a system based on BREEAM ratings. At the very least it needs radical reform because at present, most taxpayers that we encounter simply can’t be bothered.

The Annual Investment Allowance

The OTS report mentioned a simplification of the Annual Investment Allowance (AIA) scheme and we unreservedly welcome this. The majority of taxpayers who take advantage of the AIA scheme still have to make judgement calls on what is or isn’t an item of plant and machinery based on interpretation of an arcane mix of case law, legislation and HMRC’s approach to the items claimed. Of all the areas of the capital allowances regime that could be reformed, this is the one that could be done relatively quickly and have a very positive impact for taxpayers.

Our initial conclusions: more work to be done

There are many positive aspects of the OTS report which warrant further in-depth consideration. For now though, we consider it correct that the focus should be retention and reform of the capital allowances regime. One of the comments in the OTS report was that businesses didn’t really view capital allowances as an incentive to invest. Whilst we would not argue that this may be the perception, we strongly believe that this a manifestation of the complexity of the system and not the principle of using capital allowances in itself. We consider that the principle of giving tax relief through a simple, targeted, consistent and well publicised system of capital allowances can be a very effective way to encourage investment and stimulate growth. It is our view that up until now, HMRC and Treasury have never quite got to grips with what is needed and we look forward to giving our input into any reforms of the system that may be necessary. Read a full copy of the OTS report on the gov.uk website here.