Decarbonisation is the process of reducing greenhouse gas emissions and transitioning to a low-carbon economy. Decarbonisation requires significant investment in green technologies, such as renewable energy, energy efficiency, electric vehicles and carbon capture and storage.
These technologies often have high upfront costs, long payback periods and uncertain returns, making them risky and expensive to finance. Businesses are facing an unprecedented need for major capital investment.
One piece of the answer could be the UK tax system. Tax incentives can be used to help finance decarbonisation. The obvious example is the US Inflation Reduction Act. As part of this year’s Autumn Statement the Government announced that so-called “full expensing” (or giving 100% up-front tax relief for capital expenditure on infrastructure through the capital allowance code) would be made permanent. This isn’t solely about decarbonisation. Investment does not have to be green to be eligible. But it is clear that “full expensing” is intended to help with the cost of decarbonisation.
There is one problem though. The cost of investment will often be so significant that businesses will not have sufficient taxable profits to benefit from the 100% relief. Finance leasing may offer an answer.
Until the financial crisis tax-based finance leasing was a common tool used by UK banks for funding large capital investments in the UK – one benefit being that the banks could utilise the accelerated tax depreciation offered by the capital allowance regime where the client did not have sufficient taxable profits to use them, reducing the cost of funding.
Over the past 15 or so years UK tax-based finance leasing of large infrastructure assets has fallen out of favour partly because the low-interest rates reduce the cost of normal bank funding.
However, this situation may well change. We now live in a higher interest rate environment, and this does not look like changing any time soon. Perhaps more importantly, we now have 100% capital allowance rates due to full expensing.
However, there remains one major obstacle for tax-based finance leasing in the UK: the 100% capital allowance rate is not available for leasing. This means that lessors cannot claim the full cost of the asset as a tax deduction in the year of purchase. This rule was introduced to prevent schemes that exploited the 100% capital allowance rate for certain assets, such as energy-saving plant and machinery, low-emission cars and zero-emission goods vehicles.
A recent positive development is that the UK government has announced in this year’s Autumn Statement that they will consult on removing this prohibition, which could revitalise tax-based finance leasing as an effective means of funding capital investment. The government has acknowledged that full expensing will be used to support the UK’s net zero target by enabling businesses to access green technologies and by inference that the 100% capital allowance rate can encourage lessors to invest in green technologies and pass on the tax savings to lessees. The government has also stated that they will ensure that any changes to the tax rules minimise error, avoidance and fraud.
If the government follows through on this proposal, tax-based finance leasing could make a comeback in the UK, especially for decarbonisation funding. Finance leasing could offer a flexible, affordable and tax-efficient way for businesses to acquire and use green technologies, and for lessors to provide and profit from them. Finance leasing could also stimulate the market for green technologies, creating demand, innovation and jobs. Finance leasing could therefore be a win-win solution for both the lessor and the lessee, and for the environment and the economy.