ICAS responds to government consultation on the tax treatment of predevelopment costs

We have responded to the consultation on the tax treatment of predevelopment costs following the Supreme Court decision in the Orsted case. We called on the government to reconsider its position on changing the tax treatment to avoid deterring investment, particularly in renewable energy projects.

We looked at the proposals in detail in an earlier article and joined a stakeholder discussion with HM Treasury and HMRC to discuss the consultation. 

Our response supported the general principle that there should be some form of tax relief for genuine business expenditure, unless there are specific policy reasons for excluding some costs. 

Existing tax treatment

Several questions in the consultation related to the Supreme Court judgment in the Orsted case and whether this, combined with HMRC’s updated guidance, had clarified the treatment of predevelopment costs in practice. The government also wanted feedback on any remaining areas of uncertainty and practical challenges faced by businesses.

We noted that the court had adopted a narrow interpretation of the legislative wording when it decided in HMRC’s favour. It rejected Orsted’s argument for a broad construction of section 11(4)(a) Capital Allowances Act 2001, which would have allowed the predevelopment costs necessarily incurred by Orsted to qualify as expenditure 'on' the provision of plant. Instead, it decided that the statutory wording requires a close connection between the expenditure and the plant provided; here the connection was not close enough. 

The judgment still leaves considerable uncertainty in practice on exactly where the line should be drawn between qualifying and non-qualifying expenditure, but more essential predevelopment expenditure will now fall on the non-qualifying side. Determining whether there is a close enough connection between the expenditure and the plant provided won’t be straightforward. 

Our response included feedback on the practical challenges faced by community renewables projects, which generally incur expenditure on a range of surveys that are required to obtain planning and regulatory permissions. 

Types of costs

The second part of the consultation considered the types of predevelopment costs incurred by businesses, the periods over which these are incurred and whether tax relief should be available.

Again, we commented specifically on community renewables projects. We understand that the surveys and studies required prior to construction are extensive and can take place over a long period (a minimum of one year but often longer). Many of the surveys are site specific, for example, wind studies, ground condition surveys, otter surveys, traffic surveys (due to construction traffic and the transportation of abnormal loads) and ornithological studies. We also provided some examples to illustrate the breakdown of different types of costs.

As a general principle, we believe that some form of tax relief should be available for genuine business expenditure, unless there are specific policy reasons for excluding some costs. 

In the case of renewable energy projects, but also infrastructure projects more generally, various environmental surveys and assessments are required to obtain regulatory and planning consents. These surveys are desirable to ensure that environmental risks are properly assessed and managed, so we noted that it’s difficult to see why there would be any policy reasons for denying some form of tax relief.

We also suggested a broader review of the tax treatment of community renewables projects, with a view to introducing a specific simpler tax regime that provides relief for essential costs. This could encourage investment in projects with a role in delivering clean energy and support the government’s aim to increase UK community ownership of renewables projects.

Impacts

The final consultation questions dealt with the impact of the tax treatment of predevelopment costs on business and investment decisions, including competition for investment with other jurisdictions.

Feedback indicated that the tax treatment of these costs has a significant impact on UK community renewables projects. These projects generally raise funding from sources other than grants (which are largely unavailable). Typically, funding may come from equity investments by business angels, venture capital options, bank debt and community shares. 

The ability to obtain capital allowances on predevelopment costs is often critical to the funding and financial sustainability of these projects in the early years, to assist in putting them on a secure financial footing. For example, bank covenants will require debt servicing and maintenance reserves to be funded as a priority, before using income derived from renewable energy to help fund other community projects.

The confirmation in Orsted that no tax relief will be available for substantial costs, combined with other economic challenges, is likely to lead to projects not going ahead in future. 

From the perspective of international investment in renewables projects, we understand that the UK competes with many markets across Europe and beyond. In Europe these include Germany, Spain, France, the Netherlands, Nordic countries and Poland. 

Tax relief isn’t the only consideration for investors, but it’s an important one, particularly in the early stages of a project. If investors choose to go elsewhere wholly or partly because of the unfavourable tax treatment of predevelopment costs, the UK loses future tax revenues, employment opportunities and increased capacity for generating clean energy. Restricting or slowing down clean energy investment may also be a limiting factor for government plans for AI in the UK. 

Let us know what you think

We respond to tax consultations and calls for evidence and attend meetings with HMRC at which service levels, delays and other issues you raise with us are discussed. We welcome input from members to inform our work; email us to share your insights and feedback.