As well as sticks, the government is offering a bunch of carrots to get the industry to save energy. Patrick Murdock of Yewell Consulting and Martin Clowes of Elementa Consulting report
The government is forecasting that the UK may not meet its carbon dioxide emissions target. So, to encourage the property industry to reduce emissions, it has introduced a range of penalties and rewards. A lot has been written on the various penalties, in particular the impact of the climate change levy, emissions trading, pollution prevention and the impact of Part L of the Building Regulations.
This article focuses on the rewards, that is, the incentives available to the business sector on commercial projects. Predominant among these are:
- Savings in energy costs
- Enhanced capital allowances
- Energy-efficiency loans.
Given the recent increases in energy costs, advances made by manufacturers in producing more energy-efficient low-carbon technologies and the additional cost burden of Part L, we have modelled the above incentives in a case study building to see what this combination of measures now offers to owner-occupiers and tenants.
Enhanced capital allowances: in theory and practice
The enhanced capital allowances scheme was introduced by the government in 2001 to encourage businesses to invest in energy-saving low-carbon technologies.
The scheme, administered by the Carbon Trust, offers tax relief to businesses that invest in specified technologies. These include:
- Combined heat and power
- Pipework insulation
- Boilers and add-ons
- Heat pumps for space heating
- Solar thermal systems
- Motors and variable speed drives
- Thermal screens and electronic drain traps (to be withdrawn in summer 2006)
- Refrigeration equipment
- Radiant and warm air heaters
- Compressed air equipment
- Automatic monitoring and targeting equipment
- Air-to-air energy recovery equipment
- Compact heat exchangers
- Heating, ventilation and air-conditioning zone controls
- Meters/monitoring equipment
- Flow controllers and leakage detection
- Efficient toilets and efficient taps
- Rainwater filtration equipment
- Rainwater storage vessels
- Monitoring and control equipment
- Rainwater treatment equipment
ECAs therefore provide accelerated tax relief when compared with conventional plant and machinery allowances (PMAs), where the relief is given at 25% per year on a reducing balance basis over a number of years. On an expenditure of £1000, PMA provides a tax saving of £75 in the first year. With ECA, the same expenditure provides a £300 saving in the first year.
How you can maximise incentives
Early specialist involvement is the key to maximising ECAs and PMAs on a project as this will ensure that necessary design, tax planning and financial modelling is undertaken during the feasibility and design stages. The detailed capital allowances claim is prepared when the project is on site. The key actions and timeframe to maximise allowances are summarised below.
Feasibility and planning:
- Appoint capital allowances adviser
- Undertake capital allowances feasibility studies
- Establish the client's tax position.
- Model the capital cost, tax, energy savings and carbon dioxide reductions of technologies that qualify for ECA
- Design team to specify ECA technologies
- If the client is an SME, establish if the project satisfies the energy-efficient loan criteria and submit a loan application.
- Capital allowances adviser to obtain detailed cost data from contractor/cost consultant/client
- Identify expenditure qualifying for ECA/PMA
- Prepare capital allowances claim.
- Complete capital allowances analysis of contractor's final account
- Prepare year-end capital allowances claims, identifying expenditure qualifying for ECAs, PMAs and other available reliefs
- Submit capital allowances claims with client's tax computations.
- Negotiate and agree capital allowances claims with HM Revenue & Customs/Valuation Office.
Energy-efficiency loans: in theory and practice
The energy-efficiency loans scheme was introduced across the UK to encourage small and medium-sized enterprises to invest in energy-saving projects by providing businesses with interest-free loans.
The loans are available for projects with an energy payback period of less than five years and a reduction in carbon emissions of at least 0.39 tonnes of carbon per £1000 lent. Typical projects include the upgrading or replacement of lighting, boilers and heating systems.
The loans are generally available to private-sector SMEs with accounts showing a trading history of 12 months and an acceptable credit rating.
A company is an SME if it has fewer than 250 employees, less than £25m turnover or less than £17m assets. The main loan issuers and amounts available are summarised in the table attached (See table: Where you can get the loans).
To obtain a loan, an application must be made to the Carbon Trust or Loan Action Scotland. The loans are repaid over four years (five years in Scotland). Each application is subject to satisfying specific eligibility criteria.
How you can maximise incentives
Provided the loan application criteria are met, the Carbon Trust requires that the selected suppliers' quotation is submitted with the completed application form. It states that it can approve the loan within two weeks of the submitted application. If the application is successful, the Carbon Trust loan offer is valid for three months.
The energy-efficiency loans scheme has been positively received by SMEs, and the Carbon Trust has confirmed that it offered 168 loans during 2004/05.
The loans will favour SMEs with high-energy use such as manufacturers. However, the loan sums available do differ across the UK, which is inconsistent and sends out a mixed message to SMEs.
Case study: the building
The case study building (illustrated, right) is an existing owner-occupied premises used as commercial offices and a display gallery and located in a city centre. The building included many of the issues that are typical of owner-occupiers and tenants, including:
- Poorly performing existing building engineering systems
- Increased capital costs as a result of Part L and inclusion of low-carbon technologies
- Rising energy costs
- Increasing concerns about sustainability issues
The existing mechanical services were a mix of split-system air-conditioners, central air-handling plant with zone reheaters, central refrigeration plant and cast-iron sectional boilers. Automatic controls were mainly time-based, with the worst-case zone determining central plant running time. Metering was not related to the plant or space function and plant running hours were not accurately known.
The design team's brief was to incorporate low-carbon technologies and to specify ECA-qualifying technologies where possible. Other energy-savings measures were also adopted, for example solar shading.
The services replacement/upgrade decisions were based on modelling the commercially available technologies, with preference to plant items included in the energy technology list.
In addition, consideration was given to incorporating water-saving technologies.
The engineering design required modelling system options to match the building energy flows. However, calculating the energy demand proved time-consuming with the software that is currently commercially available, particularly when the first-year savings were examined.
Financial modelling was also undertaken to establish the payback of specifying ECA-qualifying low-carbon technologies, the energy savings available and the CO² reductions.
Case study: the costs
The additional capital cost of specifying low-carbon technologies included on the ECA technology list on this project is £37,820, which is an increase in the total M&E costs of about 6.6%. But these technologies will generate energy cost savings of £7043 a year and carbon savings of 67 tonnes a year (see attached PDF: Energy-saving technologies in office and gallery).
If the energy savings are modelled in isolation, the additional capital cost has a payback period of six years. If the accelerated tax benefits of ECAs are also taken into account, the payback period is reduced to two years.
The incentives available for water-saving technologies do not cover the additional capital costs for most of the available technologies. This is due to the relatively low cost of water as a resource compared with electricity and gas. The decision to invest in these technologies is purely a sustainability/green issue.
Measures were also incorporated into the case study's building design to avoid the oversizing of plant, for example solar shading. Surprisingly, not only does this expenditure not qualify for ECAs, but in many cases is not even accepted by HM Revenue & Customs as qualifying for PMAs.
If the above project were undertaken by an SME, it may have also been able to benefit from an energy-efficiency loan. In the case study, the loan (or part loan) amount would be restricted by the five-year energy payback ratio as follows:
Energy savings per year: £7043
CO2 reductions per year: 67 tonnes
Potentially available loan amount (using an energy payback ratio of 5 x £7043): £35,215
Case study footnotes
- Any capital allowances claim would be subject to negotiation and agreement with HM Revenue & Customs.
- Revenue deductions were unavailable
- Corporation tax rate assumed at 30%
- Discount rate assumed at 6%
- Energy cost inflation assumed at 5%
- Base energy costs: gas £0.0145 per kW/h, electricity £0.05 per kW/h
Our analysis and building case study demonstrate that energy savings, enhanced capital allowances and energy-efficiency loans do offer a real incentive to owner-occupiers and tenants to invest in low-carbon technologies. The ECA scheme does, however, have limitations that need to be addressed by the government if it is serious about achieving the UK's CO2 reduction targets. The main findings of our research and the feedback from industry are summarised below:
- On the engineering design side, there is a need for easily handled, linked software packages that can readily demonstrate the environmental and financial implications of quite subtle specification design changes in a clear way.
- It is difficult to identify ECA-qualifying technologies, in particular component technologies that are incorporated in major mechanical systems.
- The ECA scheme can be difficult to administer, and can increase businesses' tax compliance costs and associated professional fees.
- The scheme is only relevant to businesses that are in profit at the time the investment is made and offers no incentive to businesses that are loss-making. This is in contrast to other tax incentives such as land remediation relief tax credits, which still provide a cash benefit to companies in certain loss-making situations.
- The benefit of ECAs to property landlords is, at best, marginal. However, the effect of the European Union's energy performance of buildings directive, which could increase the value of properties incorporating energy-saving measures, may in time offer some incentive to incorporate low-carbon technologies in let buildings.
- The ECA scheme offers no incentive to businesses that implement sustainable passive measures in their projects, such as slab cooling.
- ECAs do not offer much of an incentive to invest in qualifying water technologies.
- These incentives are sufficient to encourage owner-occupiers and tenants to invest in low-carbon technologies, but not property landlords.
- The decision to invest in ECA-qualifying technologies should be based on the tax and energy savings potentially available over the whole life of the investment, not simply capital costs.
- ECAs do go some way to reducing the additional cost burden of the building services requirements of Part L of the Building Regulations.
- A building incorporating ECA-qualifying and low-carbon technologies can potentially offer a commercial advantage when a property is to be let or sold.
Patrick Murdock is a partner at capital allowances specialist Yewell Consulting and can be contacted on 0208-544 4812 or firstname.lastname@example.org. Martin Clowes is chairman of services engineer Elementa Consulting and can be contacted on 01932-232277 or email@example.com.