Its report considers the option of replacing capital allowances with accounts depreciation as a way of giving tax relief on tangible assets, following up one of the main recommendations in the OTS’s July 2017 review of the corporation tax computation. It considered the position in relation to unincorporated businesses as well as companies.

The main source of complexity which such a change could remove – if applied across the whole range of depreciating assets – is the task of determining which assets qualify for capital allowances, given that buildings do not generally qualify at present even though fixtures and other plant and machinery do.

The OTS says if this change was applied to the whole range of tangible assets, it would result in the removal of the separate, and often complex, process of determining which assets qualify for capital allowances, which at present runs alongside the depreciation process inherent in the preparation of accounts.

However, the review concludes that the undoubted potential benefits of a change in approach are not worth the upheaval involved. Such an extension of the scope of relief would come with a big price tag, require lengthy transition periods, and involve all businesses in process change even though only around 30,000 businesses claim capital allowances in amounts exceeding the present annual investment allowance of £200,000.

The OTS says replacing capital allowances with depreciation would be a radical change, and while it could be done, it is not clear that it should be done, and the longterm benefits it would deliver would not be enough to make the disruption worthwhile. There were also concerns about the impact of changes on the taxation regime as a whole, as it is difficult to isolate depreciation from wider tax considerations

The report states: ‘However, nothing in this review has made the structure of the capital allowance 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.’

Angela Knight, OTS chairman said: ‘If we were designing a system to give relief for capital expenditure of this kind from scratch, depreciation could work perfectly well and would make a lot of sense. However, our analysis has shown that the undoubted simplification benefits would not be worth the disruption of the wholesale upheaval involved.’

Instead, the OTS says the focus should be on improving the existing system, and in in particular on widening the scope of the annual investment allowance. One option it explores is extending the annual investment allowance to all assets acquired for the business (excluding the usual categories of land and dwellings), removing the need to conduct an initial allocation into qualifying and non-qualifying assets.

Paul Morton, OTS tax director said: ‘The idea of using a deprecation-based system is very attractive in principle and has repeatedly come up in discussions over the years, given the difficulties of the boundaries involved in the present system - not least in relation to buildings.

‘But it seems clear from the analysis we’ve published today that the extent of the change that would be necessary across businesses generally would be disproportionate to the benefits available.

‘However, what has come through is a strong desire to see improvements to the existing system, in particular to look at extending the scope of assets which qualify for inclusion within the present £200,000 annual investment allowance, which is such a key feature of the system for most businesses.’

Accounting depreciation or capital allowances? Simplifying tax relief for tangible fixed assets is here.

Report by Pat Sweet