Jeanette Edmiston, Partner, Project & Development Services, UK comments on the conclusions in the Office of Tax Simplification report into replacing Capital Allowances with Accounts Depreciation, June 15th 2018
In late 2017 the UK’s Office of Tax Simplification, an independent advisor to government on simplifying the tax system, began a consultation about the possibility of replacing capital allowances with accounts depreciation. The idea was one of the main recommendations the OTS made in July 2017 following a review of corporation tax computations. On 15th June 2018 they published their report and conclusions. Issues they consider are reducing the administrative burden of tax, simplifying tax rules and improving the experience of anyone who has to interact with the UK tax system.
This review looked at the impact of giving tax relief for tangible assets like fixtures in buildings, using annual accounts depreciation. At present tax relief is given through the capital allowances regime which has been in place since the end of the second world war in its current form.
Summary of the OTS conclusion
The report starts with the conclusion that it is not worthwhile to pursue this, but that the existing capital allowances system does need improving. The summary statement says:
‘Replacing CAs with depreciation would be a radical change. It could* be done and this report describes how. It is not clear that it should* be done. The long-term benefits it would deliver would not be enough to make the disruption worthwhile. However, nothing in this review has made the structure of the CA regime seem simple. It is complicated and at times unfair as between different businesses. The only benefit of the way that tax relief is currently given is that it exists already and some people are familiar with it. The CA system should be improved. Ways of achieving this are set out in this report. Some can happen quickly, others will take longer to implement.’ *The bold emphasis is the OTS’s own.
This result was expected and no real surprise. This idea had been proposed before and the reason it is not recommended to go ahead now is very much the same as the reasons it was rejected as an option last time around.
Because of the way the tax system works, taxpayers get no relief for the depreciation of assets, even though it is accepted that assets lose value over time when they are used in a business. Indeed, you will see the value of tangible assets in the accounts, together with the depreciation rates and the calculation of the depreciation amounts. However, because assets are capital in nature, the depreciation is added back for tax purposes and the relief is given by claiming capital allowances on specific qualifying assets.
This is the way things have been since the 1940’s, albeit HMRC have done an awful lot of tinkering with the capital allowances rules on a regular basis; tinkering that indicates the current capital allowances regime is by no means perfect. The fixtures rules in particular have been frequently adjusted, the last major change happening from 2012 to 2014, and still taxpayers are not fully up to speed on the implications or how to deal with the new rules even now.
The real issue
The main criticism in the report is over the way that the capital allowances regime has evolved, which has left a muddled and illogical system of allowances. Where, for example, restaurateurs can get tax relief on décor and artwork but retailers or investors in offices or industrial property cannot. Also, because of the piecemeal way the regime has developed, some parts of the system try to mimic what would be given under depreciation rules and other parts try to act as an inducement to taxpayers to invest in new assets, either directly or through expansion in development schemes. The OTS maintain therefore, that the system of capital allowances is complex and burdensome to business.
In my view, the reason that capital allowances are complex is that there are no specific rules on what does and what does not qualify for relief. Therefore, it has been down to individual taxpayers and their advisors, if they have them, to try and make a valid argument for claiming relief on individual items. In addition, even then inspectors of taxes overlay their own views and we end up with a multitude of opinions. This has resulted in thousands of taxpayers being treated differently over hundreds of items. Although there is perhaps more uniformity of opinion now than there was 10 or 20 years ago, wide variations still exist. Of more concern in our current climate of clamping down on tax evasion and punishing large corporations for tax avoidance, is the number of claims that seem to go through without being looked at.
There is clearly room for improvement in the capital allowances system and the rules could do with simplifying so that small companies have as much of a chance of taking legitimate advantage of the relief as large corporates do.
But as this review has shown, changing to accounts depreciation is not the answer, at least for now. The report freely admits that that if the change was made there would still need to be numerous adjustments made and this could leave us in a similar position as we are in now.
Depreciation could also end up being complex and burdensome to business, so what will we have gained? Implementing any change is going to suffer from being in the position we are in now – it’s a bit like the old joke when a man asks another man how you get to Tipperary and he answers that he would not start from here! As the report says, reducing the effort (and expertise) needed to put capital assets into the correct tax category would not be eliminated if the depreciation method that replaces it allows taxpayers to amend it to get the most beneficial result.
If it is ever agreed to move away from capital allowances towards depreciation, it would be such a major change that it could not be achieved in easy, simple steps. It could take years to make the transition and no doubt the transitional rules would be so complex that, for a time at least, the system would be much more, rather than less complicated.
The purpose of simplification, according to the OTS, is to reduce the costs to business of complying with the tax legislation. That means that any new system that replaces capital allowances should not cost any more to comply with, and should deliver the same or better levels of relief, otherwise there will be huge opposition from business.
Taking everything into account, I have to agree with the conclusions reached by the OTS: reforming and simplifying the capital allowances regime is the lesser of two evils. The regime needs reform, but it must be properly thought out and clearly explained and then left alone to bed in. The allowances level should remain the same or be made more beneficial and HMRC must treat all taxpayers equally and enforce their own legislation correctly and uniformly.
If we want to make capital allowance really simple for businesses to use, doing away with the game of ‘does this item qualify or not’ would be a good place to start.