Rising to the challenge

The Treasury’s announcement of a Green Technology Challenge to provide tax

breaks for green technologies owes a large debt to six years of high level lobbying

by the Environmental Industries Commission (EIC), on behalf of its members.

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.

Tax relief

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.

Profit allowance

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.

Qualifying expenditure

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;
• Motors;
• Lighting;
• 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.