Court of Appeal confirms pre-construction development costs can qualify for capital allowances

Herbert Smith Freehills LLP acted for the four successful Appellants in Orsted West of Duddon Sands (UK) Ltd and others v HMRC, which overturned the Upper Tribunal's narrow interpretation of the capital allowances rules and provided much-needed clarity on the capital allowances treatment of pre-construction development costs.

The recent Court of Appeal decision in Orsted West of Duddon Sands (UK) Ltd and others v HMRC [2025] EWCA Civ 279 is a major victory for taxpayers, particularly those involved in large infrastructure and construction projects. This case, with Herbert Smith Freehills LLP acting for the four appellant Orsted project companies ("Orsted"), provides much-needed clarity on the tax treatment of pre-construction development expenditure as it confirms that certain pre-construction costs can be qualifying expenditure for capital allowances.

Capital Allowances and the Case at Hand

Capital allowances are a form of tax relief for businesses, allowing them to deduct certain capital expenditures from their taxable profits (either in the period the expenditure is incurred or on a reducing basis over a period of years). The core issue in this case was whether various pre-construction development expenditure incurred by Orsted in the years before their offshore windfarms became operational could be treated as qualifying for capital allowances under section 11 of the Capital Allowances Act 2001 ("CAA 2001"). Section 11 CAA 2001 provides that capital allowances can be claimed for “capital expenditure on the provision of plant or machinery”, and the Court of Appeal decision focussed heavily on the meaning of "on the provision of".

The Court's Decision and Its Impact

The Court of Appeal ruled that almost all of Orsted's pre-construction development expenditure in dispute did indeed qualify for capital allowances under CAA 2001.  The Court rejected the Upper Tribunal (Tax Chamber)'s ("Upper Tribunal") decision that "on the provision of" should be read strictly and narrowly. Instead, qualifying expenditure encompasses costs of design and installation as well as costs of studies which inform such installation or design. The Court developed a three-limb test for qualifying expenditure on the provision of plant and machinery:

1. the taxpayer can demonstrate that, looking at matters objectively and with the benefit of hindsight, the expenditure informed the design of plant or machinery or how it was to be installed;
2. the expenditure related to plant or machinery which was in fact acquired or constructed; and
3. the expenditure did not arise from characteristics or circumstances particular to the specific taxpayer (e.g. financing costs).

Based on the facts found by the First-tier (Tax) Tribunal in this case, the Court held that costs on studies carried out as part of environmental impact assessment, geophysical and geotechnical studies, and other work essential for the design and installation of the windfarms qualified for capital allowances. The Court recognized that each of these windfarms was a bespoke item of plant and machinery, the design of which was informed by the particular studies in question.

A Welcome Clarification and Confirmation of the Law

This is the first significant tax case in recent years which specifically addressed the question of pre-construction development expenditure for capital allowances. The Court of Appeal's decision provides a welcome clarification and confirmation of the law, offering guidance on the types of preparatory work that can qualify for tax relief.

Potential Appeals and Future Policy Developments

While this decision is a positive development for taxpayers, it may not be the end of the road. It remains to be seen whether HMRC will appeal the decision to the Supreme Court. If permission is granted, a decision from the Supreme Court could further clarify the scope of capital allowances. Additionally, this is an area where future policy developments are possible. The Government's Corporate Tax Roadmap 2024 included a commitment to explore how to provide greater clarity on what qualifies for different capital allowances, the simplification of capital allowances legislation, and the tax treatment of what HMRC refers to as "predevelopment costs" (in response to concerns raised following the narrow interpretation in the Upper Tribunal decision in 2023). However, it seems taxpayers will have to wait a bit longer to hear Government's plans in this area, as no further announcement was made during Rachel Reeve's Spring Statement.  

Next Steps

Taxpayers involved in significant infrastructure and development transactions are encouraged to review their previous positions and consider whether further claims for capital allowances can be made in light of this decision. If you would like to discuss the case and its implications further, please feel free to reach out to the contacts listed below or your usual HSF contact.