Capital allowances ruling provides tax boost for UK projects

The Court of Appeal held that it is possible for capital allowances to be claimed on expenditure on a variety of preliminary environmental assessments and engineering studies developers will commonly carry out to determine a project’s viability or to meet statutory requirements for obtaining consent for development.

Examples cited by the court include: reconnaissance and detailed geophysical and geotechnical studies; benthos and marine mammal studies; landscape, seascape and visual assessments; ornithology and collision risk assessments; noise assessments; archaeology, wrecks and cultural heritage studies; as well as telecoms and radar interference studies.

Capital allowances can also be claimed on certain project management fees incurred in negotiating contracts for the supply of components for the project and for coordinating and evaluating the findings from the various pre-construction studies, according to the court.

The Court of Appeal considered the scope for capital allowances in the context of preliminary project studies and site investigations in a case involving companies that own and operate offshore wind farms in UK waters. The companies are part of the Orsted group.

The companies claimed capital allowances in respect of a variety of studies carried out in the years before the wind farms became operational, or, in the alternative, that the expenditure qualifies as pre-trading revenue expenditure for which they are entitled to make deductions from their profits for tax purposes. HM Revenue and Customs (HMRC) argued that no capital allowances or deductions could be claimed in relation to the expenditure at issue.

The Capital Allowances Act 2001 (CAA) provides scope for businesses to claim capital allowances – a form of tax relief – on certain ‘qualifying expenditure’. That includes expenditure “on the provision of plant and machinery”.

The question of whether the expenditure on the studies constituted ‘qualifying expenditure’ was initially considered by the First-tier Tribunal (FTT) (75-page / 1.23MB PDF), which determined that the companies were entitled to capital allowances in relation to some of the costs of the studies. However, the Upper Tribunal (UT) overturned the decision, agreeing with HMRC that the legal provisions relating to capital allowances should be interpreted more narrowly than what the companies – and the FTT – considered. 

The companies raised an appeal against the UT decision. In considering that appeal, the Court of Appeal assessed, among other things, whether expenditure on the studies constituted expenditure “on the provision of” the generation assets of the wind farm, for the purposes of the CAA.

After reviewing some established case law and applying the findings in those cases to the facts in this case, the court held that the CAA’s provisions can be applied to not just the cost of plant and machinery itself but also the costs incurred in certain necessary preliminary work undertaken to get that plant and machinery operational.

In his leading judgment for the court, which was unanimously agreed, Lord Justice Newey said: “It is clear, I think, that expenditure will not qualify for capital allowances under section 11 of CAA 2001 unless it related to plant or machinery which was in fact acquired or constructed and did not arise from characteristics or circumstances particular to the specific taxpayer. On the other hand, it appears to me that section 11 encompasses costs of design as well as costs of installation, and that the eligible expenditure will extend to costs of studies which informed such installation or design.”

“While, therefore, I am not going to attempt a provide an exhaustive account of when capital allowances are available, it seems to me that they can be claimed where (a) the taxpayer can demonstrate that, looking at matters objectively and with the benefit of hindsight, expenditure informed the design of plant or machinery or how it was to be installed, (b) the expenditure related to plant or machinery which was in fact acquired or constructed and (c) the expenditure did not arise from characteristics or circumstances particular to the specific taxpayer,” he said.