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John Healey: We introduced the starting rate of corporation tax at 10 per cent. in 2000 to provide the means for small companies to reinvest their profits in their businesses. The hon. Member for Fareham (Mr. Hoban) quoted my right hon. Friend the Paymaster General at length. I remind him that she said at the time of the introduction of the zero rate that we considered that we had the balance between the incentives to incorporate and the incentives to remain unincorporated correct, but she made clear in the Standing Committee that the Government did not have a closed mind.

It became plain that the starting rate enabled business to escape tax by retaining profits, but did not reward reinvestment specifically. As we have seen, it left the way open for some to incorporate just to reduce their tax and national insurance contributions burden, and not to take a step towards the growth that we wanted to encourage. In those circumstances, business urged simplicity on us and specialists urged us to deal with the starting rate and with the non-corporate distribution rate. The Institute of Chartered Accountants in England and Wales said in its response to our discussion paper in 2005

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I am glad that the hon. Member for Fareham acknowledged that clause 26 would indeed increase simplicity for small firms.

The hon. Member for Dundee, East (Stewart Hosie) asked a couple of questions. He asked how many businesses with profits of less than £10,000 a year would be affected by the changes. I can tell him that about 370,000 companies with profits of less than £10,000 will be affected by the clause. The median tax increase for all companies affected will be £475 a year.

The hon. Gentleman obviously has not looked at the regulatory impact assessment that we published alongside the pre-Budget announcement in December, but if he looks at that and the update that we provided at the time of the Budget in March, he will find not only an answer to his question about how many companies would be affected, but a published breakdown of the number of companies, sector by sector.

Ed Balls: Does my hon. Friend agree that in making tax policy, one is always balancing tackling avoidance with providing the right incentives? It would be simpler if we abolished the 20p rate for small companies and had instead just one rate for all businesses, but that would be bad for small companies, just as it would be wrong to abolish the 10p starting rate for capital gains tax and to go back to the single 40p rate that applied in 1997. In the end, it is about striking a balance between avoidance and providing the right incentives.

John Healey: My hon. Friend cuts to the very heart of the policy challenges that any Government face, and which we have been trying to tackle since we took office in 1997. As he said, it is a question of getting the right balance between creating incentives for small businesses to start up and grow, and preventing the abuse and avoidance that we tend to see promoted and taken advantage of. In dealing with the situation that we faced, we had to decide whether to box around with further legislation—and thereby prevent—the marketed schemes and practices that we wanted to discourage, or whether to take instead the step   urged on us by businesses, their representative organisations and tax specialist organisations: to create a simpler regime. Clause 26 does that by getting rid of the non-corporate distribution rate and the starting rate.

The hon. Member for Fareham described the clause as simply a tax-raising measure, but it is about fairness, not raising taxes. I refer him to the pre-Budget report, in which we announced the measure.

Mr. Newmark: Will the Financial Secretary give way?

John Healey: I will gladly give way when I have finished making this point. We said in the pre-Budget report:

Mr. Newmark: In addressing the important issue of fairness, I would like the Financial Secretary to deal with the point made by the Paymaster General on 7 July 2004. She said:

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What is fair about that?

John Healey: The unfairness at the heart of the system and the challenge that we face is that many companies are incorporating simply to reduce their tax liability, not because their business demands suggest that that is the proper legal form for them. Companies that do not incorporate are clearly tax-disadvantaged, compared with their competitors.

I want to pursue the fairness point because it is important and at the heart of our argument. The hon. Member for South-East Cornwall (Mr. Breed) made some key broad points about the importance of small firms in a modern economy, and of Governments being able to implement measures to support their start-up and growth. He said that he was not sure what a fair tax system is. We should remember that as things stand—clause 26 is designed to change this—a self-employed person with profits of £20,000 a year pays some £1,800 more in tax and national insurance than they would pay if they were a company paying corporation tax and taking profits as dividends. That cannot be right, which is why we will continue to keep this issue under review, and why we have taken steps through clause 26.

As I said, these provisions were announced in the pre-Budget report, and clause 26 implements them. They will encourage reinvestment by increasing first-year capital allowances to 50 per cent. for the year starting this April. Some 4.2 million small businesses—not just those that are incorporated—are eligible to benefit from this increase in first-year capital allowances.

Mr. Hoban: Does the Financial Secretary accept that the Red Book puts the cost of the measure, and therefore the benefit to all business, at £60 million? However, the fact that it is a one-off measure prevents small businesses from planning for a stable future and making long-term investment decisions.

9.45 pm

John Healey: As I have tried to explain, the purpose of clause 26 is to refocus the support that we give to small firms on measures likely to increase their incentives to invest, to reinvest profits, and to grow.

Clause 26 will also help by introducing the simpler accounting system for all small businesses that we promised in the pre-Budget report. It will double the annual threshold for the VAT annual accounting scheme so that 1.08 million firms will become eligible. If we are successful in getting the state aids clearance that we require for the cash accounting scheme, the 733,000 small companies currently eligible to benefit under that scheme will rise to 790,000.

Helen Goodman : It may help the Committee if my hon. Friend the Financial Secretary were to put this matter in a wider context. In my constituency of Bishop Auckland the number of new small businesses is at an all-time high. To what extent does he feel that these measures are the cause of such a high rate of small business creation, and is the pattern repeated across the country?

John Healey: I am grateful for that question, but a range of factors make up the business and economic
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environment that allows small firms to start up and prosper. My hon. Friend mentions the number of new firms in her constituency of Bishop Auckland, but there are now 570,000 more businesses in the British economy than there were in 1997. The business start-up rate is faster than for many years, and that is based on our stable and steadily growing economy, but the operation of the tax system can aid or hinder the formation and growth of small firms. The provisions of clause 26 will introduce a simpler corporation tax structure, and in a modest way will assist the process. All firms will benefit, including those in Bishop Auckland.

Of course, we can do more to support business, and my hon. Friend the Member for Bishop Auckland (Helen Goodman) is one of those who constantly urges the Government to do so. In the Budget 2006, we have made clear our desire to join business and its representative organisations in looking at doing more. I look forward to the continuing discussions in that regard.

The measures in clause 26 were welcomed by business representatives as a constructive way forward. I urge the Committee to support its standing part of the Bill.

Question put, That the clause stand part of the Bill:—

The Committee divided: Ayes 304, Noes 137.

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