The Chancellor of the Exchequer, Gordon Brown, in his November 1999 Pre-Budget Report, announced £150m support for business investment in low carbon technologies under the climate change levy package. This has allowed for the proposed introduction of a 100% first year Enhanced Capital Allowance scheme, and a £50m fund for energy efficiency and renewables.

The proposed ECA scheme follows a number of representations from business proposing that the Government should introduce tax incentives to encourage firms to make energy saving investments.

In December 1999 the Government issued a Consultation Document, 'Energy Efficiency Measures under the Climate Change Levy.' Following analysis of the response to the Consultation the Chancellor proposed that the ECA scheme would support CHP, boilers, motors, variable speed drives, lighting, refrigeration, pipe insulation materials and thermal screens, which meet the relevant energy efficiency criteria. Other technologies can be added subject to satisfactory methods of certification and subject to cost-effectiveness criteria and controls on Exchequer cost.

The full list of products will be published shortly. To avoid distorting the timing of investment decisions, the Government decided to allow investments in approved products and systems made after the publication of the list qualify for enhanced allowances. Formal claims, however, can only be made after April 2001, in line with the legislation for ECAs being included in the Finance Bill 2001.

In designing the scheme for enhanced capital allowances, the Government is drawing on the model operating in the Netherlands.

The Key Features of the Scheme

• all businesses will be able to claim enhanced capital allowances, regardless of size, industrial or commercial sector or location;
• enhanced capital allowances will permit the full cost of the investment in specified technologies to be relieved for tax purposes against taxable income of the period of the investment;
• the qualifying technologies will have to meet defined energy efficiency criteria. They will be published in a List, and the criteria will be reviewed on an annual basis;
• there are no territorial restrictions on manufacturers wishing to place their products on the list or the source of products;
• only investments in new and unused machinery and plant can qualify.

• provide energy efficiency advice and audits to small and medium sized enterprises;
• promote the development of "new" sources of renewable energy; and
• encourage the research, development and take up of low carbon technologies and energy saving measures through a "Carbon Trust".

The Government believes that a Carbon Trust is the most effective way of delivering the energy efficiency programme and funding research into low carbon technology. The Government will be taking forward the establishment of the Trust - as a private company limited by guarantee - over the next few months. The devolved administrations can buy into the Carbon Trust if they view that as the most effective method of delivering their energy efficiency work.

• Assets that are buildings or structures as defined by Schedule AA1 Capital Allowances Act 1990 (details can be accessed at www.inlandrevenue.gov.uk) as these assets do not qualify for any capital allowances given on machinery and plant.
• Machinery and plant that are long-life assets, that is, assets with an expected useful economic life of 25 years or more from new.

• improving energy efficiency criteria, by setting technological specifications above what otherwise would be the standard;
• promoting 'new' technology, in particular those technologies that have entered the market, but have yet to gain market confidence;
• increasing market penetration - there must be scope for an energy efficient technology to increase its relative share of the market;
• correlation between demand and cost - enhanced capital allowances should only be available on products where there is a reasonable expectation that the tax-supported cost will increase sales.

Users of ABB’s variable speed drives will benefit from the new Enhanced Capital Allowances, following the inclusion of the company’s drives on the DETR’s list of approved products. This means investments in variable speed drives can be set against corporation or income tax bills in the year of purchase, in effect reducing the cost by some 15%.

This will cut the payback time for variable speed drives, which often is less than 18 months already, even further.

Using variable speed drives in pump and fan applications saves a minimum of 20%, but can save as much as 60% of the energy, compared to an application running at full load. There is vast scope for savings in industry where many motors run at full speed quite unnecessarily in systems regulated by valves, vanes and other restrictions. The variable speed drive, by contrast, ensures that no more energy than necessary is drawn by adjusting the speed of the motor to the required output. The ECA scheme is designed to boost the usage of variable speed drives and other energy efficient equipment.

Normally, the cost of capital goods is written off over a number of years, 25% per year on the decreasing balance. This means, that on a £10,000 investment, £2,500 is written off in the first year. In the second year, 25% is written off the remaining £7,500, i.e. £1,875; and so on. The whole amount will never be claimed back this way; companies normally continue for eight years, after which some 90% of the value has been written off.

The Enhanced Capital Allowance enables users to offset the full cost in the year of purchase. This has three benefits. Firstly, the whole amount, rather than some 90%, is claimed back. Secondly, tax relief is granted on this greater amount. And thirdly, cash flow improves as the money is reclaimed in the first year rather than over a number of years.

Example:

Investing £100,000 under the reducing balance scheme, assuming 31% company tax.

Now let’s say that we invest £100,000 with Enhanced Capital Allowances, assuming 31% company tax.

You write off £100,000 in year 1, £10,011 more than the total over 8 years in the reducing balance scheme. This means you can claim £31,000 tax back, £3,104 more than under the reducing balance scheme. As all this is done in the first year, you get £23,250 more back in this year, money that can now be gainfully employed in your business. If we assume that the return on capital employed in your business is 15%, the money will earn you between £1,200 and £1,900 per year for each of the eight years, or a total of nearly £12,000 over the period. Compared to the old scheme, the Enhanced Capital Allowances will have saved you nearly £15,000, or 15% of the purchase cost.

So, how will this affect the payback calculation for variable speed drives? Let’s say that we have a pump in an air conditioning system. The 75kW pump motor is running continuously, 24 hours a day, at full speed and the flow is regulated with a valve; average flow is 50%. The cost of electricity is assumed to be 5 pence per kWh. The motor will in this case consume 75% of the rated power, or 56.25kW, at a cost of £67.50 per day, or £24,638 per annum.

Now we remove the valve and install a 75kW variable speed drive from ABB, costing £7,292. The flow is regulated by the speed of the motor, which is dropped down to 50%. The motor will not only run slower, but because it is not running against a restriction, it will also run more efficiently. So efficiently, in fact, that the power consumption will be just 28% of the rated power, or 21.5kW, at 37% of the previous cost. The payback on energy alone is six months. But because the ECA effectively means a 15% discount from the government, the payback time will be shortened by a month, to five months.

Please note: This is based on the latest information available and may be subject to review. E&OE.