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Following announcements made in the 2007 Budget, HMRC have published a consultation document on proposed changes to the current capital allowances regime.

Budget 2007 announced a series of wide-ranging reforms to the structure of business taxation in the UK. Changes to the corporation tax (CT) rate structure and capital allowances regime have been accompanied by an increase in the level of the research & development (R&D) tax credit and the introduction of a new payable credit for environmentally beneficial investment.

The Government is now seeking feedback on the three new elements of the capital allowances regime:

• the annual investment allowance (AIA);
• the definition of ‘integral fixtures’ to be assigned to the 10 per cent pool; and
• payable enhanced capital allowances for environmentally beneficial investment.

The consultation document marks the beginning of a two-stage approach to consultation on the annual investment allowance and the new definition of integral fixtures. The first stage is an outline of the reforms, with sufficient detail for business to scrutinise and offer their views. This stage of consultation will end on 19 October 2007. Towards the end of the year, the Government will produce draft legislation for a further round of technical consultation.

Broadly, the proposals contained in the consultation document are as follows:

Annual Investment Allowance (AIA)

The AIA will replace the existing system of first-year allowances for small and medium sized enterprises (SMEs) as the Government’s primary tax incentive to support investment by SMEs. The proposed AIA will operate as a 100 per cent first-year allowance for capital investment in standard plant and machinery, capped at £50,000 per year for each individual business or group of companies. Expenditure above the £50,000 threshold will be dealt with in the standard capital allowances regime.

The AIA will not be available for expenditure on business cars, but expenditure on all other plant and machinery, including integral fixtures and long-life assets, will be eligible. The AIA does not replace existing 100 per cent first-year allowances for environmentally beneficial technologies; these will continue to be available. Expenditure that qualifies for these 100 per cent allowances will not qualify for AIA.

So that the AIA can act as an effective incentive for investment that is not open to abuse, rules are necessary to ensure that businesses cannot fragment to benefit from multiple annual allowances. The consultation docuemnt outlines the Government’s proposals for managing the risk of abuse.

Integral fixtures

The 2007 Budget announced that ‘integral fixtures’ would be separately identified and included in a new 10 per cent asset pool. This is a better reflection of the actual, average rate of economic depreciation on these assets and will reduce the tax system’s distortive impact on investment decisions. There may also be assets that are currently treated as being part of the building, but which, applying the new approach, will in future be included in the 10 per cent pool.

The document sets out the Government’s proposed definition of integral fixtures, based on a short list of integral fixture assets, and considers an alternative definition, based on a purposive test.

Enhanced capital allowances

Enhanced capital allowances (ECAs) are a key part of the Government’s programme to manage climate change. They allow the full cost of an investment in designated energy saving and environmentally beneficial plant and machinery to be written-off against the taxable profits of the period in which the investment is made.

Budget 2007 announced an expansion of the existing arrangements with the introduction of a payable ECA from April 2008.

Building on the established model used for the SME R&D tax credits, the new payable ECAs will allow loss-making companies to surrender the element of their losses attributable to their qualifying expenditure in return for a cash payment from Government. The new payable credits will apply to companies only; unincorporated businesses will not be able to access the payable credit. The Government will announce the rate at which the new payable ECA can be claimed at a later date.