At the Autumn Budget 2024, the Government announced plans for a consultation on the tax treatment of predevelopment costs, those early-stage expenses incurred before a project or asset is fully operational. However, this consultation has now been postponed following a significant Court of Appeal decision. The Government is currently considering the implications of this judgment before proceeding further.

Why is this relevant?

Predevelopment costs can be substantial for owner-managed businesses undertaking new projects, property developments, or infrastructure investments. Historically, there has been uncertainty over whether these costs qualify for capital allowances, a form of tax relief for capital expenditure, especially when incurred before an asset is constructed or operational.

The Orsted Case: A turning point

The legal case (Orsted West of Duddon Sands (UK) Ltd and others v HMRC) concerned offshore wind farm operators who incurred significant costs on studies and surveys, such as environmental impact assessments and geotechnical investigations, before construction began. HMRC argued that such costs were not eligible for capital allowances, as they were too remote from the actual provision of plant or machinery.

The Court of Appeal disagreed, ruling in favour of the taxpayers and establishing a new ‘three-limb’ test for determining whether predevelopment expenditure can qualify for capital allowances:

1. The expenditure must inform the design or installation of the asset in question.
2. The asset must actually be acquired or constructed.
3. The expenditure must not arise from the specific circumstances of the taxpayer (for example, financing costs are excluded).

This decision means that a wider range of pre-construction costs, such as environmental studies and design work, could now be eligible for capital allowances, providing valuable tax relief for many businesses.

What happens next?

While the Court of Appeal’s decision appears to offer some clarity for now, the matter may not be settled. HMRC may appeal to the Supreme Court, and the Government is considering legislative changes to provide greater clarity and potentially simplify the rules around predevelopment costs.

The consultation originally planned for early 2025 is on hold while these implications are reviewed, and stakeholders are invited to share their views with the Treasury in the meantime.

Practical steps you might consider…

• Review Past and Planned Expenditure: If your business has incurred or is planning to incur significant predevelopment costs, now is a good time to review these in light of the new Court of Appeal guidance.
• Document the Purpose of Predevelopment Costs: Ensure you keep clear records demonstrating how each cost informed the design or installation of the asset. This will be crucial if you wish to claim capital allowances under the new ‘three-limb’ test.
• Monitor Further Developments: The situation is evolving. Keep an eye on government updates regarding the postponed consultation and any potential legislative changes.
• Engage with the Process: The government is actively seeking feedback from businesses on the impact of the judgment. You can submit your views directly to the Treasury at predevcosts@hmtreasury.gov.uk.

Conclusion and next steps

The Court of Appeal’s decision is a positive development for businesses seeking tax relief on predevelopment costs, but the situation around the tax treatment of predevelopment costs may very well change again, depending on further appeals or legislative action.

If you’d like to discuss how these changes may affect your business or need help reviewing any predevelopment expenditure, please get in touch.