Select Committee on Trade and Industry Written Evidence

Annex 2


  A company spending £200 million per year for five years on revenue expenditure (say carbon permits) would get immediate 30% tax relief. This would result in a net cash cost of £700 million (ie £200 million less 30% tax relief, for each of the five years).

  To allow a proper comparison it is necessary to take account of the timing of the cash flows and discount them all back to a single point at the start of the five year investment period. Allowing for this time value of money (at 10% nominal discount rate), leads to a net present cost of £584 million.


  A company spending £200 million per year for five years constructing a power plant with a life of 20 years (say a CCGT) would have to wait until the plant was operational and would then receive tax allowances at 25% per year on a reducing balance basis.

  Reducing balance at 25% per year means that in the first year of operation a tax allowance of 25% of the total capital expenditure (ie 25% of £1,000 million = £250 million) is generated. At a corporate tax rate of 30% the value of this allowance would be £75 million (ie £250 million x 30%). Having used £250 million of tax allowances in the first operational year, the remaining balance would be £750 million (ie £1,000 million capital minus the £250 million allowance used in the first year). The second year's tax allowance would then be 25% of that £750 million (£188 million) and the value of that tax relief would be £56 million (ie £188 million x 30%). This declining balance allowance structure continues for the life of the asset.

  This would result in a net present cost of £688 million (ie 18% higher than the same amount of revenue expenditure). The initial outlay would have been the same as in Example 1, but the tax relief is worth less because it has been delayed for five years and has then been spread across the operating life. Furthermore the tax allowances are not indexed for inflation so lose value at the nominal value of money.


  The same capital expenditure programme for a long-life asset (say a nuclear or clean coal plant) would receive allowances in a similar way to short-life assets but at only 6% per year on a reducing balance basis.

  The tax allowance in the first year of operation would be only £60 million (ie £1,000 million x 6%) which would be worth £18 million at 30% tax rate. The value of the tax relief in the second operational year would be £17 million and so on.

  This very slow run out of the tax allowances would give a net present cost of £757 million (ie 30% higher than revenue and 10% higher than shorter life assets). In investment terms, these "penalties" are directly equivalent to increasing the capital cost by that amount. Given the highly capital-intensive nature of low-carbon technologies (nuclear, clean coal, renewables), the tax structure would be a key factor in investment choices.

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Prepared 21 December 2006