If you are a business that pays income or corporation tax, any capital expenditure on plant and machinery may qualify for tax relief by way of capital allowances. These allowances allow you to deduct some or all of the value of an item from your profits before you pay tax.
In the case of energy efficient purchases and investments the deductible rates can be significantly greater because of the environmentally beneficial nature of the asset. These are known as enhanced capital allowances (ECA).
The introduction of enhanced capital allowances
Enhanced capital allowances were first introduced at the turn of the century to encourage businesses to invest in energy and water efficient technologies and products.
This includes low-emission new cars, new vehicle electric charge points, new zero-emission goods vehicles, certain new energy-saving and water-efficient equipment, and certain new gas refuelling equipment.
By allowing a 100% first year tax relief on investment in ECA qualifying items, this provides a significantly increased tax saving over the alternative allowances available on these items.
The net effect of enhanced capital allowances is that you can potentially write off the entire cost of purchasing an energy or water efficient product against your taxable income in a single tax year.
In this way you can reduce investment costs and improve cash flow, whilst minimising the impact of your business on the environment.
The criteria for enhanced capital allowances
To qualify for enhanced capital allowances your business must own the plant or machinery, have installed it ready for use or be using it already in their trade and have incurred the expenditure.
Only new plant and machinery are eligible for enhanced capital allowances, where used or second-hand plant and machinery do not qualify.
The plant or machinery must also be a listed product, meeting the energy-saving or water conservation criteria specified by the Carbon Trust.
Qualifying ECA products & technologies
The government decides on the availability of enhanced capital allowances, with the qualifying technologies being published in the Energy Technology List (ETL) and the Water Technology List (WTL), typically on a yearly basis.
The ETL and WTL are government-managed lists of energy and water efficient plant and machinery that qualify for full tax relief. For a product to be on the ETL or WTL, it must meet specific energy-saving or water conservation criteria.
The list of energy efficient technologies and products which are currently eligible for enhanced capital allowances include the following:
- Air to air energy recovery
- Automatic monitoring and targeting equipment
- Boiler equipment
- Combined heat and power
- Compressed air equipment
- Heat pumps
- Heating, ventilation and air conditioning equipment
- High speed hand air dryers
- Motors and drives
- Pipework insulation
- Refrigeration equipment
- Solar thermal systems
- Uninterruptible power supplies
- Warm air and radiant heaters
- Waste heat to electricity conversion equipment.
The water efficient technologies include the following:
- Cleaning in place equipment
- Efficient showers
- Efficient taps
- Efficient toilets
- Efficient washing machines
- Flow Controllers
- Leakage detection equipment
- Meters and monitoring equipment
- Rainwater harvesting equipment
- Small scale slurry and sludge dewatering equipment
- Vehicle wash water reclaim units
- Water efficient industrial cleaning equipment
- Water management equipment for mechanical seals.
These lists are due to be updated for 2019/20 to reflect further developments in eligible technologies.
You will be able to claim 100% first year capital allowance on a product if it’s on the ETL or WTL at the time of purchase. If it has been taken off the list, or is added at a later date, the ECA item will not qualify for relief.
Claiming enhanced capital allowances
Enhanced capital allowances are commonly referred to as a first year allowance, allowing you to deduct 100% of the cost of a qualifying ECA item from your pre-tax profits. This rate is significantly more generous than alternative available capital allowances.
You can also claim enhanced capital allowances in addition to your annual investment allowance (see below), whereby they don’t count towards your limit.
However, you are only able to claim the full 100% if you make the claim within the same tax year as the purchase for your qualifying item.
That said, if you don’t claim all the first year allowances you are entitled to, you can still claim part of the cost in the next accounting period using what’s known as ‘writing down allowances’. This is where you deduct a percentage of the value of an item from your profits each year.
You are able to do this at any time provided you still own the qualifying item, although it offers much less attractive rates.
To claim enhanced capital allowances, you will need to do so through your business’s income or corporation tax return, in the same way as any other capital allowance.
Profit & loss making companies
Enhanced capital allowances are a straightforward way for a business to improve its cash flow through accelerated tax relief.
If a profitable business pays corporation tax at 19% (for 2018/19), every £100,000 spent on qualifying items would reduce its taxable profits in the year of purchase by £19,000.
However, loss-making companies can also realise a tax benefit from their investment in qualifying technologies with what’s known as ‘payable ECAs’. Here a company can surrender any losses attributable to enhance capital allowances in return for a cash payment from the Government.
The amount payable to any company claiming payable ECAs will be expressed as 19% of the loss that is surrendered. So if a company surrenders a loss of £100,000, the payable ECA it will receive is £19,000.
These tax credits do, however, operate with an annual cap that equates to either £250,000, or the total of the company’s PAYE and National Insurance liabilities for the year in which the claim is made, whichever is greater.
An increase in the annual investment allowance
The good news is that enhanced capital allowances only become necessary in circumstances where any business investment exceeds the annual investment allowance (AIA).
This means that your business will still benefit from the AIA on any expenditure on plant and machinery up to a specified annual amount each year, whether this be on energy or water efficient technologies and products or otherwise.
It is only where businesses spend more than the annual limit that you will need to seek additional relief under the capital allowances and enhanced capital allowances regime.
For the last three years, since 1 January 2016, the AIA has been set at just £200,000. However, from 1 January 2019, businesses investing more than £200,000 in plant and machinery will now benefit from a temporary increase in its annual investment allowance up to £1 million.
This increased AIA limit is set to remain in place for a period of two years and will provide significantly faster tax relief for plant and machinery investments between £200,000 and £1 million, helping businesses to invest and grow.
Proposed new measures for ECAs
Given the significant increase in the AIA limit, it is perhaps of less concern that a new proposal, due to come into effect in April 2020, will see an end to enhanced capital allowances for energy and water efficient plant and machinery.
For many businesses the majority of the expenditure incurred on plant and machinery will still be eligible for full relief under the new £1 million annual investment allowance.
Key takeaway for enhanced capital allowances
Enhanced capital allowances can offer significant tax benefits for businesses heavily investing in qualifying plant and machinery. However, with the introduction of the increased annual investment allowance, many businesses may not need to rely on this type of tax relief.
Needless to say, it remains important for all businesses to seek to minimise their impact on the environment by investing in energy efficient or environmentally beneficial technologies and products, regardless of the tax advantages.