Taxing decisions

From April 2001, the construction industry will face a new tax – the much heralded, keenly awaited and little understood Climate Change Levy. The Levy is all part of the government's commitment to the international Kyoto Protocol, which seeks to reduce carbon emissions and improve energy efficiency.

The Levy will be roughly equivalent to 15% of the cost of gas and electricity. more precisely 0·43 p/kWh on electricity, 0·15 p/kWh on gas, 0·96 p/kg (equivalent to 0·07 p/kWh) on lpg and 1·17 p/kg (equivalent to15 p/kWh) on coal/coke. Fuel oils will not attract the Levy as they are already subject to excise duty.

So who pays? All UK businesses and public sector organisations – industry, commerce, agriculture and public sector – will pay the Levy via their energy bills. There are certain exemptions:

• some forms of renewable energy

• good quality combined heat and power (chp)

• natural gas in Northern Ireland (for up to five years)

• energy products that act as both fuel and feedstock within the same process

• electricity used in some electrolysis processes

There are also some discounts. Horticulture will have a 50% discount for up to five years, while 80% discounts will be available to energy-intensive consumers who sign up to energy saving or emissions reducing targets agreed between government and relevant trade associations. Continuation of these discounts will depend on energy savings being demonstrated.

What happens to the money?

The Levy is expected to raise about £1 billion from the domestic sector in 2001/02. Most of this will be returned to employers through a reduction in employers' National Insurance contributions of 0·3%.

To offset the effect of the Levy, businesses can invest in energy efficiency measures that will often save more than the Levy increase. Those in energy intensive sectors can participate in the 'climate change agreements' to save energy and qualify for the 80% discount. The levy therefore encourages energy saving by two routes: by improving the economics of investing in energy efficiency and by encouraging participation in agreements to save energy.

Enhanced capital allowances

If the Levy is the stick, there is also a carrot in the form of enhanced capital allowances.

Some of the money raised by the Levy – £150 million per year – is earmarked to provide direct support for energy efficiency. Of the £150 million, £100 million per year will provide financial incentives through the taxation system – these are the enhanced capital allowances. This money represents a substantial increase in expenditure over existing government programmes to encourage energy efficiency. Enhanced capital allowances will complement energy advice activities as part of a broader, integrated policy. The other £50 million will be used as a fund to support energy efficiency measures.

As part of the taxation system, businesses are already able to claim capital allowances on provision of machinery and plant. A business spending £1000 on machinery can reduce its liability to corporation tax in the year of the expenditure by 25% of this expenditure – and by 25% of the remaining balance in the following years (so it will claim a £250 allowance in the first year; 25% of £750 in the second year, and so on).

For small and medium-size businesses, the first-year allowance is 40%. Capital allowances also cover installation costs and professional fees that are directly related to the acquisition and installation (but feasibility studies, for example, would not be allowed).

Enhanced capital allowances allow the whole cost to be offset against tax liability in the first year. However, they will only be available for plant and machinery that satisfies a number of energy efficiency criteria. The immediate benefit of enhanced capital allowances to businesses will be improved cash flow in the year that the qualifying equipment is purchased. Of course, having claimed the allowance in the first year, there is no allowance left to claim in following years. The value of the improved cash flow to a business will depend on the circumstances of the particular business.

What equipment is eligible?

The basic criteria is that specific items of equipment should be significantly more energy efficient than what is considered standard for similar products, and that the allowances should increase the market share of energy efficient products.

This means that the technologies will have to have potential for increasing market share and for price to be a significant market barrier. Eligibility for enhanced capital allowances will be withdrawn from products once they are established in the marketplace.

A practicable qualifying and compliance system also has to be feasible for the products. As the system of allowances has to operate within the general framework of the existing capital allowance rules, there has to be a reasonably simple way for manufacturers to demonstrate compliance. This can be done either using existing test methods, or via an energy technology list of eligible products.

The equipment has to be plant and machinery. In tax terms, buildings are treated differently from plant and machinery under the taxation system. That means energy efficiency measures that are an integral part of a building cannot benefit from allowances, simply because there are no capital allowances in the first place.

Initially, enhanced capital allowances will be available on specific technologies, namely:

• boilers (including add-ons)

• pipe insulation

• lighting

• combined heat and power

• motors

• variable speed drives

• thermal screens

• refrigeration.

Subject to cost constraints and satisfactory methods of certification the range may increase in future years.

The initial criteria against which the list of eligible products will be judged has been developed by DETR in consultation with relevant trade sectors. Full details are on www.eca.gov.uk or through the Environment and Energy Helpline on 0800 585794. These criteria will be reviewed at regular intervals.

A UK energy technology list will be published on the web site. This will contain the list of eligible technologies and will be updated regularly. To claim the allowance the purchaser should complete their self-assessment tax return for the period during which the expenditure is incurred.

Manufacturers can get their products on the list by submitting applications to the DETR. Forms are available on the web site. The onus is on the manufacturer or sole trader to provide the necessary evidence.

The qualifying criteria were published on 24 June. The initial list will be available in November. Purchases made after the publication of the list will be eligible for the allowance scheme, but claims can only be made after April 2001.

A £50 million fund has been set up, managed by a non-profit company, limited by guarantee, to accelerate business take-up of energy efficient technologies. It will run an integrated programme of market development measures ranging from advice and information, fiscal incentives, education and training, and research development and demonstration. It will manage the business elements of the Energy Efficiency Best Practice Programme.