The allowances claimed for a large-scale hydroelectric power generation scheme demonstrate how smaller businesses can claim for costs associated with installation.
SSE Generation Ltd (TC06618) provides electricity, gas and energy services. It spent £300m constructing a hydroelectric scheme in Scotland, and claimed capital allowances on £260m (87% of the cost), but HMRC initially accepted only £34m (11%) of the claim.
The hydroelectric scheme collects water via a network of water intakes. These feed into conduits which channel the water to a reservoir behind a concrete dam (no allowances were claimed for the reservoir or dam). The water then passes through a main intake beside the dam into the headrace, which is a conduit to take the water by gravity to the generating equipment.
The turbine and generation equipment are housed below in a power cavern excavated from solid rock. Alongside this is a cavern accommodating the transformer (which steps-up the power to high voltage for the national grid). The water discharges through a tailrace conduit into Loch Ness. There are also tunnels to transport water, carry the main high voltage electrical output cable, and to provide personnel and vehicle access.
What was the outcome?
Most of the items in dispute were allowed, except for:
part of the cost of one type of conduit
excavating the two caverns (although crane-related works were allowable)
creating the main access tunnel, connection tunnel and the emergency tunnel
Where the costs are related to the construction and installation of assets, the first step is to establish exactly what is the “item” to be considered for the capital allowances claim. The tribunal had to decide whether it was looking at a single entity, or individual single items, or categories of assets.
In the SSE Ltd case everyone agreed that it was an agglomeration where each separate part needed to be considered on a piecemeal basis by looking at its function. After the project was divided into its key functional parts, these were further sub-divided into different construction categories, where this had a bearing on their capital allowances treatment.
Order of tests
This case clarifies the order of tests to apply when establishing whether an item qualifies for plant and machinery allowances.
In the first instance, HMRC officers are instructed by their capital allowances manual para CA21010 to disallow expenditure under either CAA 2001 s21 (buildings) or s 22 (structures, assets and works). This how HMRC’s barrister urged the judge to approach this case.
However, the judge rejected this approach and concluded that the first step should be to establish whether the expenditure on the provision of the asset qualifies under the general conditions of CAA 2001 s11 because it is plant under common law. In other words, does it function as business apparatus? Only if that the answer to that question is ‘yes’ does it then become necessary to consider whether the cost is disqualified by CAA 2001 s21 or s22.
What the labels mean
The judge rejected a contention by HMRC that “labels applied for convenience” to assets by engineers and others helped determine their statutory meaning. He observed that “many words are chameleons and the context can often provide colour”. He suggested, for example, that words such as “dam” had different meanings to different people that were “somewhat elastic”.
Land alteration costs
The most interesting point in this case related to the treatment of land alterations. These occur in major civil engineering projects, but also during more modest everyday projects.
Expenditure on “any works involving the alteration of land” is disallowed by CAA 2001 s22(1)(b). Nevertheless, “the alteration of land for the purpose only of installing plant or machinery” is excluded (or as the judge put it, “saved”) by CAA 2001 s23, list C, item 22 from applying the disallowances in CAA 2001 s21 and s 22. This means the cost may qualify under the basic principles of CAA 2001 s11 as expenditure on the provision of the plant.
Here, HMRC tried to persuade the judge that anything which involved the alteration of land should be disallowed. However, the judge concluded that this could only apply where land alteration was the objective in its own right.
The argument over the land alterations led to a counter-intuitive outcome regarding the conduit, where the judge rightly noted that “the law of capital allowances is full of fine and sometimes apparently arbitrary distinctions”. The judge partly disallowed the costs associated with a type of conduit called “cut and cover” (a discrete concrete structure placed into an excavated trench and then covered back over), using this logic:
He considered whether the concrete structure was “plant” and decided that it was, because it helped transfer water from the intakes to the reservoir.
He ruled that it was also an “aqueduct”, which meant that it was disallowed by CAA 2001 s22(1)(a), list B, item 1.
He held that any land alterations were only to install the concrete structure (which in step 1 he had determined was “plant”).
Therefore, the land alteration cost to excavate the trench and backfill it was eligible as expenditure on the provision of plant (the concrete structure), but the concrete structure (the relevant plant itself) was ineligible because it was specifically barred by CAA 2001 s22.
This contrasted with “drilled and blasted conduit lined with shotcrete” (a drilled and blasted void with a sprayed concrete lining and rock bolt stabilisation). This was also “plant” and an “aqueduct” for the same reasons.
However, here the matter was “finely balanced”, but the judge considered that the conduit was a “single item” made up of the void and concrete lining. Consequently, both the land alteration (drilling and blasting) and the concrete lining, which comprised the single item, were “the alteration of land for the purpose only of installing plant or machinery”. Therefore, allowances were available for all of the expenditure.
Although few of us will ever be involved with a project of the type and scale undertaken by SSE Ltd, the outcome is relevant to wider practice. However, as the case was heard at the first-tier tribunal the decision is persuasive, rather than a binding precedent. I wonder whether HMRC will appeal it.