Watch out for the capital allowances cliff edge

17 February 2023

It seems like a very long time ago when, in March 2021, then chancellor of the exchequer Rishi Sunak introduced the capital allowances ‘super-deduction’ and the special rate pool first-year allowance. These were temporary incentives to encourage capital investment by companies, as part of efforts to stimulate renewed UK business activity after the coronavirus pandemic restrictions.

Valuable but short-lived incentives

As a reminder, the super-deduction and special rate pool first-year allowance provide companies with an in-year deduction of 130% and 50% respectively on qualifying expenditure. Due to the uncapped nature of these reliefs, they have proved to be incredibly valuable.

Both incentives were introduced for a two-year period commencing on 1 April 2021 and ending on 31 March 2023. This relatively short window is, however, regrettable, limiting their effectiveness in incentivising large scale capital projects, which can often take a number of years to plan, approve and implement.

Consequences of withdrawal

The legislation sets out that any expenditure incurred after 31 March 2023 is not eligible super-deduction or special rate first-year allowance expenditure. This abrupt cut-off creates a ‘cliff edge’ effect for obtaining the benefit of these reliefs, which may produce some surprising results due to the rules that determine when capital expenditure is incurred for capital allowances purposes, the general rule being that expenditure is incurred as soon as there is an unconditional obligation to pay for it.

The impact of the withdrawal of these reliefs should be considered on a case-by-case basis, but in the scenarios below we have highlighted some issues to be aware of.

Purchase of machinery

The purchase of a large item of machinery is one case where a cliff edge scenario may arise and is illustrated below, where a company has placed an order for a machine costing £5m. The relevant facts are as follows.

Machine ordered - January 2023 (40% deposit paid).
Machine delivered - May 2023 (50% payment).
Machine commissioned - December 2023 (10% balance paid).

In this example, the super deduction will most likely not be available on any of the expenditure as the unconditional obligation to pay does not generally arise until the delivery of the item, in this case in May 2023, with a further rule delaying the date when capital expenditure is incurred when it is not required to be paid until at least four months after the unconditional obligation to pay has arisen, in this case for the final payment in December 2023. The clear area of possible contention here is that the acquiring company may be expecting some, if not all, of the expenditure to be super-deduction expenditure on the basis that the contract was entered into and a deposit was paid within the window for qualification. However, the requirement to pay a deposit is unlikely to amount to an unconditional obligation to pay in most cases.

Milestone contracts

The impact of the withdrawal of these incentives may not be felt so severely where the contract is a ‘milestone contract’. A milestone contract arises where an asset which is being constructed under the contract becomes the property of the purchaser as it is being constructed and payment becomes due when agreed stages of the work (milestones) are satisfactorily completed. These types of contracts are commonly found on construction projects, where the obligation to pay is normally conditional on certification of the work to that point. Therefore, the super-deduction and special rate first-year allowance should be available in respect of qualifying expenditure certified before 31 March 2023, even if the works are not completed until after that date.

Action required

There is very limited planning that can be done around timing, and it may be challenging to bring forward capital expenditure whilst also meeting the unconditional obligation to pay rule.

The key actions for businesses are therefore to ensure an appropriate understanding of the rules, confirm that budgets and cost-benefit analyses accurately reflect the tax-impact of capital expenditure, and identify any cases where it is possible to accelerate expenditure such that it qualifies for the time limited reliefs. Some may also wish to lobby the chancellor to extend the fast-approaching cliff edge on 1 April 2023.

Many companies have shared their experience of supply chain delays, caused by factors outside of their control, that will reduce their ability to claim the super-deduction, and those that deliberately made investment decisions within the two-year qualification window may be asking why they should be negatively affected by such outside factors. The chancellor could address this unfairness by extending the relief until, say, the end of 2023 – it will be interesting to see whether this may feature in his forthcoming Spring Budget.