The tax treatment of predevelopment costs has been the subject of a recent Supreme Court decision. This is likely to mean that capital allowances will be restricted for some predevelopment costs. The government has consulted on the impact of the decision and whether the current rules could affect investment decisions.

Predevelopment costs are costs incurred in the early stages of a project, before the main development work begins. They can include feasibility studies, surveys, design work, planning and other regulatory approvals and preparatory activities. The amount and type of costs will vary between projects and sectors.

The Supreme Court decision earlier this year established that expenditure must be incurred ‘on the provision of’ plant or machinery to qualify for plant and machinery capital allowances. This means that some predevelopment costs will not qualify. For example, expenditure on securing planning permission would not normally meet this test. Where such expenditure is capital in nature, it may therefore receive no tax deduction.

A HM Treasury consultation was published in July and sought views on the types of predevelopment costs businesses incur and the extent to which uncertainty remains following the Supreme Court decision and the effect of the current rules on investment decisions. The government says it is not currently minded to change the tax treatment of these costs.

Concerns have been raised that this could increase the commercial risk associated with long-term development projects, particularly where substantial costs are incurred before a project proceeds. There have been calls for clearer HMRC guidance on the treatment of historic claims and future tax relief for predevelopment costs.

The government has said that it will publish its response to the consultation in due course. In the meantime, businesses undertaking significant investment projects should review the treatment of their predevelopment expenditure and consider whether costs previously treated as qualifying for capital allowances remain eligible under the current rules.

Businesses investing in qualifying assets may be able to claim the Annual Investment Allowance (AIA) and deduct the full cost of eligible purchases from their profits before tax. This can help by reducing the amount of taxable profit in the period the investment is made.

The AIA can generally be claimed by sole traders, companies and partnerships where all the partners are individuals, on most plant and machinery up to the available allowance. The current AIA limit is £1 million, meaning many businesses can claim immediate relief on significant investments rather than spreading the tax relief over several years.

Qualifying purchases may include items such as machinery, equipment and certain business assets. However, the AIA cannot be claimed on business cars, assets previously owned for another reason before being used in the business or items given to the business.

The allowance is claimed in the accounting period when the asset is bought. Businesses should ensure they use the correct purchase date, which may depend on when contracts are signed or payments become due.

If a business does not want to claim the full amount of AIA, for example because it has low profits, it may choose to claim writing down allowances instead or split the claim between AIA and other capital allowances.