Court of Appeal allows capital allowances for design fees

In an important judgement, the Court of Appeal (CoA) has concluded that capital allowances are available for certain preliminary costs relating to the construction of offshore windfarms. The disputed expenditure related to studies that informed the design or installation of plant and was therefore held to be ‘on the provision of’ plant.

The decision will be relevant for assessing capital allowances eligibility across many types of plant and machinery, with the findings likely to be of particular interest to businesses engaged in major infrastructure and other capital projects, including those operating in the renewables sector. If the decision had gone the other way, it is unlikely that the taxpayers would ever have obtained relief for any of the costs, which totalled more than £45m. This shows the value of giving detailed consideration to the treatment of preliminary costs for capital allowances purposes.

Background

The taxpayer companies in Orsted West of Duddon Sands (UK) Limited & others v HMRC (previously Gunfleet Sands Limited & others v HMRC) incurred significant expenditure prior to the construction of new offshore windfarms. This included costs exceeding £45m on various environmental and technical studies, on which capital allowances were claimed. HMRC challenged this on the basis that the studies were too remote from actual expenditure on the construction of the windfarms to be regarded as ‘on the provision of’ plant and machinery.

The First-tier Tribunal (FTT) allowed the taxpayer’s appeal in respect of some of the disputed expenditure but agreed with HMRC that some of it was too remote as it was not ‘necessary’ expenditure. The Upper Tribunal (UT) took a very different approach, concluding that none of the expenditure qualified because it was not on the actual construction, transportation or installation of the plant.

An important point determined in the lower court was that the wind turbines and array cables in each windfarm (the ‘generation assets’) collectively constituted ‘plant’ for capital allowance purposes, rather than each wind turbine and array cable separately being an item of plant. This has important ramifications for the CoA decision.

The Court of Appeal decision

The CoA overturned the UT decision and went further even than the FTT, deciding that the costs of all the studies that it was asked to consider qualified for capital allowances. Further submissions were invited in respect of the initial high-level scoping work to determine which environmental studies were required, to determine its correct treatment. There were also costs on certain studies that the CoA was not required to consider, as the taxpayers had withdrawn their appeals in relation to these costs.

The CoA stated that, in general, expenditure will be on the provision of plant and machinery and thus capital allowances can be claimed, where all of the following criteria are met:

• The taxpayer can demonstrate that, looking at matters objectively and with the benefit of hindsight, the relevant expenditure informs the design of plant or machinery or how it is to be installed.
• The expenditure relates to plant or machinery which is actually acquired or constructed.
• The expenditure does not arise from characteristics or circumstances particular to the specific taxpayer.

The specific studies undertaken by the taxpayers were held to meet these criteria. In the course of its detailed review, the CoA made several observations that may be helpful for other businesses assessing capital allowances eligibility. Some of the key findings are noted below:

• There is a distinction between expenditure that informs the design or installation of the relevant plant or machinery, which qualifies for capital allowances, and expenditure incurred to determine whether plant or machinery should be acquired, which does not. An apportionment may be necessary if an element of each is present.
• There is also a distinction between ‘off-the-shelf’ and bespoke plant or machinery – there will not be any qualifying expenditure relating to the design of the former.
• It is important to identify the relevant asset when assessing what constitutes a design cost. As the relevant plant in this case was the generation assets as a whole, rather than each individual turbine and array cable, a study that determined which particular type of turbine was appropriate was advising on how the generation assets should be designed, rather than what plant should be bought.

Impact for other businesses

If it had not been overturned, the narrow approach set out by the UT would have resulted in many preliminary costs being ineligible for capital allowances. Consequently, the CoA decision will come as relief for many businesses, not just those directly involved. It provides a framework for others to assess the eligibility of costs of a similar nature. This will be applicable in many different circumstances, though the findings are likely to be of particular interest to those embarking on major infrastructure projects and other large scale projects involving plant and machinery. In the renewables sector alone, the principles may be applicable to onshore wind, solar and hydro-electric schemes, in addition to offshore windfarms.

It is currently unclear whether HMRC will seek to appeal to the Supreme Court, so this may not be the end of the story. It is also important to note that the Corporate Tax Roadmap published last Autumn stated that the government was “aware of business concerns regarding predevelopment costs” and promised that a consultation would be launched with the aim of reducing uncertainty in this area of tax. So far, no further details have been published and it remains to be seen what impact this decision, and any further appeal, will have on the consultation.

The very different approaches taken by the FTT, UT and CoA will have left many businesses in limbo, unsure whether their preliminary costs qualify for capital allowances, and show how difficult it can be to interpret the capital allowances legislation. Engaging a capital allowances specialist at an early stage will help to ensure claims are technically correct and optimised, and this decision shows how valuable this can be.

For more information, please get in touch with Paul Smith, or your usual RSM contact.