Rising to the challenge
The Green Technology Challenge (GTC) tax incentive will provide 100 per cent first year enhanced capital allowances (ECAs) for companies investing in innovative technologies which contribute to environmental protection, but what, exactly will it mean to your business? IEM first reported on the GTC at consultation stage in October last year, and since then the government has made a number of important announcements prior to the scheme's launch. Jason Rayfield reports on what the GTC is, what technologies it will cover, and most importantly, how it could save your company money.
Subsequently in the 2002 Budget, the government made the following announcements:
The government's statement of intent, as far as environmental taxation goes, is to support the polluter-pays principle for environmental policy; that is; those that pollute should be responsible for paying for the environmental cost that they impose on society as a whole. However, there are circumstances where tax incentives - rather then levying taxes - may be the most appropriate policy instrument.
Enhanced Capital Allowances, which form the heart of the Green Technology Challenge, are a particular type of tax incentive which enable businesses to take relief on the full cost of investment in the first year (this relief is normally given at a rate of 25 per cent a year). ECAs bring forward relief, so that it can be set against profits of a period earlier than would otherwise be the case. Businesses are therefore able to write-off the whole cost of their investment against their taxable profits of the period during which they make the investment.
Returning to my opening paragraph: so what does all this mean to your business? In order to gain clarity, we need to understand the nature of capital allowances. Blaise Marin-Curtoud is a partner and head of tax group at Gouldens, and in an EIC presentation on GTC at the recent et2002 exhibition in Birmingham, he outlined the tax implications when applied to business.
According to Blaise, in order to understand the GTC scheme introduced in 2001, it is necessary to have a general understanding of the scheme of current capital allowances legislation. The following is taken from his presentation.
Corporation Tax (for companies) and Income Tax (for sole traders and partnerships) are taxes on profits. Although the starting point for any calculation of the tax due by a business is its profits as shown in its accounts, rules have evolved which allow (and often require) businesses to adjust their accounting profits for tax purposes. In particular, depreciation charged by a business in its accounts is not an allowable deduction (for tax purposes) in computing profits.
However, tax legislation does have a set of rules which allows businesses to deduct from their profits an amount which is similar, in nature, to depreciation: allowances for certain types of capital expenditure, generally referred to as capital allowances.
Under the plant and machinery allowances code, a business which incurs capital expenditure on the acquisition of an item of plant or machinery can claim an allowance of 25 per cent (on a reducing balance basis) against its profits. Say, for example a manufacturing company acquires a machine (for a total sum of £1,000,000) which it uses to manufacture its product. If all relevant conditions are satisfied, the company can deduct £250,000 from its profits for the first year (£1,000,000 at 25 per cent), £187,500 for the second year (£750,000 at 25 per cent) and so on until the balance of the expenditure is negligible.
In simplistic terms, the allowance is the tax equivalent of the depreciation charged by the company in its accounts for the element of machinery. In tax terms, the allowance gives relief from tax (spread over a number of years) for the cost of the machine. This reduces the actual cost of the machine to the company.
It is important to keep in mind that allowances, even if they are given initially, may subsequently be clawed back. Where a business which has claimed allowances on an item of machinery sells that machinery, it will either suffer a charge (referred to as a balancing charge) if the machinery is sold for more than the balance of the expenditure on which the allowances have been given (the tax written down value), or could claim a balancing allowance.
As explained earlier, plant and machinery allowances are usually given at a rate of 25 per cent on the residue of the qualifying expenditure incurred. Under the ECA scheme introduced for energy saving equipment, provided all relevant conditions are satisfied, allowances will be equal to 100 per cent of the qualifying expenditure in the first year.
This means that if a particular item of plant and machinery qualifies under the new scheme, the person entitled to allowances will see the purchase price of the machinery reduce by 30 per cent for companies or 40 per cent for individuals and partnerships.
The conditions for the expenditure to qualify are fairly simple. The equipment must be unused and not second-hand. This prevents enhanced allowances being claimed where the item of machinery is bought from a person which already used the machinery. The expenditure must be incurred on or after 1 April 2001, as well as being incurred on energy saving equipment - defined as equipment which is specified as such by the Treasury.
In practice, the government has decided that it would adopt, for these purposes, a list of equipment which is published by DEFRA and updated on a regular basis. The following are the broad categories of equipment which have been included on the list
- Combined heat and power (CHP);
- Refrigeration equipment;
- Boilers and add-ons;
- Thermal screens;
- Variable speed drives (VSD); and
- Pipe insulation.
Hopefully, some light has now been shed on exactly what the Green Technology Challenge is and ways that it can benefit your business, but before you reach for your accountant's business card, it is important to bear in mind a few practical issues.
The first of these is to ensure that the equipment purchased meets the technical specifications which are set out in the energy product list. In respect of the items falling under the combined heat and power heading of this product list, it is necessary for a certificate of energy efficiency to be enforced in relation to the plans. The certificates are issued by the Secretary of State for the Environment.
The second point concerns a scenario where all of the items of plant is specified on the products list, the amount of the allowance will, in most cases, be equivalent to the expenditure incurred.
However, where the energy saving equipment is part of a larger piece of plant and machinery, special rules apply to determine the amount of expenditure on which the enhanced allowance can be claimed in respect of a particular component where the item of plant and machinery incorporate more than one such component, the enhanced allowance can be claimed on the aggregate of all the values listed for the qualifying components.
Where the item of plant and machinery which comprises a component specified on the list is purchased and paid for in instalments, it will be possible to claim an allowance based on a proportion of the instalment payments made in the relevant period. That proportion is broadly equal to the proportion which the aggregate of the expenditure on the energy saving components bears to the aggregate expenditure on a particular item of plant and machinery.
Another crucial detail is to ensure you have sufficient supporting evidence of having actually incurred the expenditure when making a claim under GTC. This procedure is unfortunately complicated in cases where the energy saving item is only part of a larger piece of plant which itself does not qualify for any enhanced allowances. It will be necessary for the tax payer to be able to demonstrate that the relevant components meet the criteria set out in the energy production technology list and to consult the list in order to determine the expenditure on which the enhanced allowance can be claimed.
A greener future?
Although much progress has been made on the Green Technology Challenge, the scheme has been criticised for its lack of scope. The EIC, for example, represents all sectors of the environmental technology and services industry, and as such continues to press the government for the incentive to encourage the development and use of innovative environmental technologies across all sectors of the environmental technology market. At present the GTC does not cover a whole range of key sectors, including control of air pollution from industry, remediation of contaminated land, oil spills, waste treatment and recycling.
EIC actively supports the GTC and is working towards its success; but it will
continue to press the government, which is committed to reviewing the GTC, following
EIC lobbying, for it to be extended to all sectors to help tackle the many other
environmental problems the British public faces.