Capital allowances - Focus on full and partial expensing

In the fifth article of our series, Tax in 2024 for the future energy sector, the TLT Tax team provides an overview of the recent changes to the capital allowances rules.

Why do capital allowances matter when building out and holding operational renewable generation assets?

Capital allowances are a form of tax relief which provide for the writing down of the cost of capital expenditure on qualifying plant and machinery over time – in the context of renewable generation projects this could be solar panels, battery assets or wind turbines for instance. Therefore, projects which involve significant upfront expenditure on plant and machinery can generate valuable tax deductions which can be used over a period of time to reduce their corporation tax liability. When modelling the financial performance of a renewable generation asset the availability of capital allowances may be included or taken into account in calculating financial projections.

What has changed in the capital allowances rules?

The Spring Budget 2023 introduced two new temporary first-year capital allowances available for a three-year period ending in March 2026.  These have now been made permanent as announced in the Autumn 2023 budget.  This means that a company can now permanently claim:

• 100% capital allowances on qualifying main rate plant and machinery investments (full expensing), meaning that for every pound invested its taxes are cut by up to 25p; and

• 50% first-year capital allowances for special rate expenditure (partial expensing).

This change means that allowances at higher rates may be available when expenditure is incurred on the acquisition of plant such as solar panels, wind turbines, battery assets and cables.  The capital allowances analysis should now be simpler and more beneficial.

What is full expensing?

Full expensing is an enhanced capital allowance that can be claimed by companies at a 100% rate. It is available for assets which would otherwise fall within the main rate pool.

This means that if a company buys qualifying plant and machinery and claims full expensing allowances, it can reduce taxable profits by the total value of the assets in the first year.  This allowance is very generous compared to the main rate pool of writing-down allowances of 18% which would otherwise apply to qualifying plant and machinery.

What is partial expensing?

Partial expensing is another type of enhanced capital allowance which enables a company to claim a deduction of 50% of its expenditure on qualifying plant and machinery where that expenditure would otherwise qualify for capital allowances at the special pool rate of 6%. Renewable energy assets such as solar panels and wind turbines would fall within this category.

The balance of the expenditure is subject to writing down allowances at the special pool rate on a reducing balance basis.

When can these allowances be claimed?

Full expensing and partial expensing are both “first-year allowances” meaning that they are only available in the first year in which the expenditure is incurred.  If claiming these allowances would give rise to losses, consideration needs to be given to how those losses can best be utilised to create maximum value for the company.

What expenditure qualifies for these first year allowances?

For expenditure on plant and machinery to qualify for either full or partial expensing, the following conditions must be satisfied:

• the expenditure is incurred on or after 1 April 2023;

• the expenditure is incurred by a company which is within the charge to corporation tax; and

• the plant and machinery must be new and unused.

Full expensing is only available for expenditure on “main rate” plant and machinery and partial expensing is only available for expenditure on “special rate” plant and machinery.  Therefore, it is necessary to determine whether plant and machinery expenditure is main rate or special rate expenditure.

What is “main rate” and “special rate” expenditure?

Main rate expenditure is qualifying expenditure on plant or machinery that does not fall within defined special rate categories. Examples of assets within the main rate are equipment, IT assets and plant or machinery that has a useful life of less than 25 years.

On the other hand, there are specific items which will always be treated as falling within the special rate pool. Expenditure on solar panels and wind turbines, for example, is included as special rate expenditure and therefore benefits from partial, but not full, expensing. 

What if the plant or machinery is sold?

If an asset on which full or partial expensing was claimed is subsequently sold the company may be subject to a balancing charge for capital allowances purposes. Therefore, in such a case a company can suffer a partial loss of the benefit originally claimed in respect of capital allowances.

How do these allowances interact with the Annual Investment Allowance?

Like full and partial expensing, the Annual Investment Allowance (AIA) is designed to encourage investment by allowing businesses to deduct the full value of expenditure up to £1 million per annum on qualifying plant and machinery from their profits before paying corporation tax. 

Given that special rate assets are only eligible for partial expensing, companies might sometimes combine the two reliefs.  This will enable them to claim full relief (at 100%) first under the AIA in respect of special rate assets up to the annual limit and then to claim permanent expensing (at 50%) in respect of the balance.  

TLT comment

Whilst the move to permanent full and partial expensing is a positive development for this sector and more widely, there is more that the government could do in this space to incentivise investment into renewable generation projects.  For example, making full (rather than partial) expensing available to plant and machinery expenditure used in the construction of wind and solar farms would be a significant benefit.