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As my hon. Friend the Member for Hornchurch (James Brokenshire) said, Government policy has driven that. There are various rates. The history of the zero percentage rate, an issue arising from last year’s Finance Bill, is instructive. The 10 per cent. band was introduced in 1999. By 2002, it had become a zero per cent. band, introduced for the purpose of encouraging growth and entrepreneurial spirit. Inevitably, as predicted by the Institute for Fiscal Studies and
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accepted by the Government, sole traders incorporated. It was an entirely rational thing for them to do. The consequence was that the Government perceived that they were losing too much revenue—hence the introduction in 2004 of complex anti-avoidance measures and the abolition in 2006 of the zero per cent. band.

During the entire period, enormous time, effort and cost were incurred by various individuals incorporating. Indeed, the Government appeared to be encouraging them to do that and benefit from a lower tax regime. The consequence was that they were castigated and treated as tax avoiders. They were practically treated as cheats. That did nothing for the relationship between small businesses and the Government, and it increased the difficulties of the two systems running in parallel.

Even following the abolition of the zero per cent. band, it is still advantageous to be incorporated in most cases. In that context, the Government have changed the system once again by raising rates, as announced in the Budget, beginning with the increase from 19 to 20 per cent. in the Bill. I do not know whether the Government’s intention ultimately is for the two systems to be tax neutral. We are some way from that. In most cases, it is still better to be incorporated because there is just corporation tax, whereas with employment there are income tax and national insurance contributions. However, if the intention is to be tax neutral, will the Government do anything to encourage those companies that have moved into the incorporated sector to move out again? If so, many small businesses will be concerned that a decision to disincorporate will be treated as a deemed transfer of goodwill, and they will want disincorporation relief to secure their financial position. Again, it is not entirely clear what the Government want to do.

I said that the approach is incoherent. In an attempt to solve the perceived problem with incorporation, the Government have increased the rate of corporation tax, but they have also raised the application of national insurance contributions, as announced in the Budget, while also increasing the threshold for higher rate income tax, which means that it would be possible to receive a higher amount of dividends without paying any tax. The two approaches do not entirely fit together. Again, it demonstrates an incoherence. On the one hand, one part of the Treasury is attempting to address the difference between the two structures, while on the other it is raising the higher rate threshold, which I support, and encouraging more sole traders to incorporate. The problem remains much the same.

I am also unclear on the Government’s defence of the changes when they state that they are tax neutral. They say that the increase in rates will always be put into increased allowances for small businesses. Of course it will apply only to small businesses that invest, but that does not mean that it will target entrepreneurial companies with the potential for growth. A consultancy may well not be the type of business that can invest heavily, yet may be exactly the sort of potentially high-growth entrepreneurial business that the Government should try to encourage, and profess to want to encourage.


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During our debates on the Budget, Conservative Front Benchers made it clear that we would oppose those changes, and I have a distinct recollection of Ministers’ saying, “Well, that is a £1 billion hole in the public finances.” Unless I am missing something, I cannot quite see how opposing a tax-neutral proposal will create a £1 billion hole in the public finances, unless there is an additional argument about tackling avoidance. If that is the case, I can see where Ministers are coming from, but it still means £1 billion of extra taxes that would not otherwise have been imposed on small businesses.

Small businesses are vital to our economy. They are a potential source of larger businesses, and they nurture an entrepreneurial spirit. However, they also suffer disproportionately from high compliance costs. One of the reasons why they have suffered in recent years is ever-increasing tax complexity. If we are to have a Budget and a Finance Bill for small businesses, we must tackle that complexity and reduce the compliance burden, whether in tax or elsewhere. That is how we can best preserve and nurture our small businesses.

If the Government are not prepared to reduce the tax burden on small businesses as a whole, which is what will happen if they do not address the issue of incorporation, a more fundamental and careful review of our taxation system will be necessary. In a piecemeal manner, by adjusting rates here or there, the Government are trying to address the conundrum of corporation tax. However, there may come a time when we shall need to examine the issue more fundamentally, and perhaps consider altering the schedular way in which tax is calculated so that distinctions between taxation of companies and taxation of individuals diminish. A competitive and friendly tax environment is vital for small businesses. The Budget and the Finance Bill have failed to provide that environment.

8.43 pm

Mr. Philip Dunne (Ludlow) (Con): It is a pleasure to follow my hon. Friend the Member for South-West Hertfordshire (Mr. Gauke), who, in his forensic manner, managed to explain some of the inconsistencies in the Government’s approach to incorporated businesses, unincorporated businesses and sole traders. I intend to say a little about that as well.

Members will be pleased to learn that in the time available to me—which I regret to say is rather less than the amount in which others have been able to indulge—I shall not undertake a tour d’horizon of the Bill and the Government’s economic record. I want to focus on specific measures that stem from a belief expressed earlier today in the Chief Secretary’s remarkable claim that the Bill “strengthens investment incentives for small companies”. I think that that is what he said, but, as I shall explain, it is fundamentally not what the Bill achieves. It may be the intent, and the intent is very noble, but it will not be the outcome.

I remind the House of my interest declared in the Register of Members’ Interests.

Commenting specifically on these aspects of the Bill, the Institute of Chartered Accountants has said:


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That is the fundamental problem. Three measures lie at the heart of the problem, and I shall focus on two. The first is the abolition of industrial buildings allowances and agricultural buildings allowances as the quid pro quo for the changes to the smaller companies’ corporation tax rate. What will be the consequence of that? Those allowances respond to investment decisions for substantial capital spend that are not made overnight. It can take several years in some cases, and certainly many months, for a business to commit to a substantial investment of that kind, and to remove the allowances overnight without any interim arrangements is misguided and will introduce uncertainty into investment decision making. Business investment in this country will suffer, particularly in respect of small businesses.

The Government claim to support innovation and entrepreneurship, and I support that, too; it is a laudable objective. They have made a reasonable stab at supporting it, but judging by the number of VAT registrations they are not doing as well as they did when they inherited the economy that we left them in 1997. I will not make any further historical references—other Members have done that—but let me point out that there were some 15,000 fewer new VAT registrations in 2005, the most recent year for which figures are available, than there were in 1997, and that there are some 7,000 more deregistrations per year than there were in 1997. That suggests that entrepreneurial activity is in decline, rather than growing. However, I accept that not all VAT registrations are for business; they are for charities and other non-business purposes as well.

The Government have got themselves into a muddle over the form of business activity that they are seeking to encourage. According to Department of Trade and Industry statistics, some 12 per cent. of businesses are in the form of partnerships. Unincorporated businesses comprising more than one principal are partnerships, of which there are more than 500,000, and there were 515,000-plus in 2005, out of 4.3 million businesses in total. Therefore, there is a significant amount of such businesses, and they range in size.

The hon. Member for Dundee, East (Stewart Hosie) referred to small-scale business activity in Scotland, and the same pattern exists across England, although the proportion of larger businesses in the rest of the United Kingdom is higher than it is in Scotland. However, there are 13 per cent. fewer partnerships than there were in 1997. I suspect that, in part, that reflects the point of my hon. Friend the Member for South-West Hertfordshire about the drive for sole traders and small businesses to incorporate to take advantage of previous Government tax incentives.

The proposals contained in what are called the “sideways loss” measures in the Budget could have a significant impact. They could have ramifications that go far beyond the Government’s acknowledged intent, which is to prevent avoidance—they fall within the anti-avoidance section. All Members are in favour of clamping down on avoidance, but why are the Government singling out the partnership structure for
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special penalties, and where is the logic in their position that they should treat unincorporated partners so harshly compared with incorporated businesses or sole traders? There is no logic in that; it appears to be a jumble.

The Government have perceived that there is an avoidance problem and, as usual, have adopted an all-embracing measure to try to clamp down on it, ignoring the impact that it will have on bona fide business. It is curious that they are seeking to introduce rules that will drive legitimate business offshore. I am aware of examples of substantial investments by individuals that will now be taken offshore because they do not trust the tax regime enough to make the investments onshore, as they have done previously—or these measures might stop them getting off the drawing board in the first place. My hon. Friend the shadow Chief Secretary cited one or two examples in her remarks, which illustrated that point. I fear—it gives me no pleasure to say this—that these Treasury Ministers have such little experience of the real world of business that they cannot rein back the zealots in HMRC from whom, I assume, these anti-avoidance measures originate. I do not imagine that Ministers think them all up themselves. The Revenue identifies an abuse and comes up with a solution, but there is a lack of practical business experience among the Front- Bench team, who are not prepared to stand up to the Revenue and say that it is overstepping the mark and that its proposals will have unintended consequences. I do not believe that such thought processes go on, although I would be delighted to be corrected by the Paymaster General when she winds up.

John Mann: From my own practical business experience, I know that the one thing that infuriates honest business people, such as me and—I am sure—other hon. Members present is when people bend the rules to such an extent that they give themselves a competitive advantage. Is not that what business really thinks?

Mr. Dunne: The hon. Gentleman is right that it is appropriate to clamp down on specific schemes that are set up to avoid the rules. I have no argument with that, but it is not the point that I am trying to make. The point that I am seeking to demonstrate—I shall give one or two examples—is that many bona fide commercial activities between partners will be constrained and, frankly speaking, stopped by these measures. Those activities should not be stopped and the solution should be to introduce alternative measures, such as perhaps a clearance or other mechanism, which may already exist in other areas of the tax code, to allow them to take place.

Hon. Members have mentioned the farming industry. Many farms are run as partnerships between members of the same family and the partnership structure is used to allow interests to change over time as the younger generations come in and the older generations retire. The interests of the partnership can be altered through the life of the partnership, and that is an attractive way of managing affairs. New partnerships are often set up when a new member of the family begins to participate. Unfortunately, farming follows the biblical pattern—I know that, as a farmer myself—and some years one makes a loss. One can often have losses in the early years of a new
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partnership. It would be wrong for such activity to be made non-deductible when one would have to pay tax if one were lucky enough to be making profits in the early years of a new farming partnership.

Another example is the biotech industry, a high risk industry in which some individuals may be prepared to take significant risks with large amounts of money. That risk should be reflected and, if it goes wrong, individuals should have the chance to offset the losses on those substantial risks against their other income. Another example would be the hotel industry. When one sets up a new hotel, one generates losses in the early years while one builds up the room rate. I am aware of examples in which individuals have decided to go into business together as one of them alone cannot raise sufficient money to launch a hotel. People therefore group together in partnerships because it is a good structure.

Dawn Primarolo: Perhaps the hon. Gentleman could explain whether he agrees with the proposition that people who make losses but have nothing to offset them against should be able to sell those losses to others who have no losses but wish to buy them to offset against the tax that they should legitimately pay.

Mr. Dunne: It is possible to have a test of why an individual is making an investment. If they are making the investment only because they have a loss they wish to offset, they would fail the test. That is what the legislation should be designed to correct, not to attack legitimate and genuine investment for bona fide commercial purposes. I very much hope that in Committee we shall be able to propose amendments that allow the Paymaster General to recognise that fact, as the Bill’s existing measures will lead to the end of many bona fide commercial transactions.

Dawn Primarolo indicated dissent.

Mr. Dunne: The right hon. Lady shakes her head, but that is the case. Mike Warburton of Grant Thornton has indicated that about £300 million of investment in carbon trading schemes and wind farms will be put at risk by the Chancellor’s decision. I do not imagine that either the right hon. Lady or the Chancellor want that to happen.

Several aspects of the relief seem completely arbitrary and bizarre. The first is the 10-hour limit for an active partner in an investment scheme—10 hours’ work per week is required to demonstrate that a person is a bona fide investor. That limit will exclude inactive partners from investing in a business. Many entrepreneurial individuals, such as those featured in the television programme, “Dragons’ Den”, might invest in the form of a partnership structure and provide entrepreneurial flair and drive, as well as access to their time, but not 10 hours a week to oversee the business. I use that example because it will resonate around the House. A large number of business angels, operating in large and small groups, provide money and specialist advice to small businesses setting up on their own. Those individuals are increasingly tending to use the partnership structure, but they will be unable to do so in future because they will not be able to provide the 10 hours required to qualify.


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The second arbitrary aspect is the limit of £25,000 for eligibility for relief, even though many projects involve individual investments of substantially more than £25,000. I cannot imagine where that sum came from—it seems to have been magicked from thin air—but it will mean that such investments will be made only in tiny projects. The amount is unrealistic in terms of help for small businesses getting off the ground, and if the Government insist on retaining the regime the limit should be raised to a much more meaningful amount. I propose £1 million.

Another aspect of the relief that will have a substantial impact on reducing business investment relates to the proposals for the venture capital trust industry. I understand from the Red Book that the provisions were imposed on the Government by the EU, but that it was done in a mealy-mouthed way. The Government have not stood up to the EU and have chosen to define the state aid rules inappropriately. There are 110 venture capital trusts in Britain. In 2005-06, they raised £750 million; in 2006-07, the tax year that has just ended, they raised only £110 million. The reason is that the measure was introduced in the last few weeks before the end of the tax year when most of the money comes in, so we can already see the impact of the proposal. Raising funds in that industry has ended because the amounts that can be invested in an individual company are too low. A substantial equity gap will be created between those who can invest £25,000 under the sideways loss relief limit and up to £2 million through a venture capital trust and the commercial, private equity development capital finance provided at the higher end.

In conclusion, it is particularly damaging for venture capital trusts that the Government chose to interpret the EU state aid rules with a limit of 50 employees to define a small company, even though it was open to them to have chosen a limit of 250 employees as the medium company size. Why on earth did not they choose the larger number? It would have allowed far more companies to participate in venture capital trust investment in future and allowed the prospect of continuing a viable industry, which I fear the Government will shut down.

8.59 pm

Stewart Hosie (Dundee, East) (SNP): The Chief Secretary, in his introductory remarks, said that the Treasury team was managing the economy based on an immovable constraint. He was then interrupted by an intervention, but I suspect that he meant that borrowing had to be kept at 40 per cent. of GDP, and the Government claim to have done that. I mentioned the £169 billion of private finance initiative liabilities up to 2030-31, and I would be fascinated to find out what the capital borrowings are that lead to that amount of repayment liability. How much of that is off balance sheet? How much of it should actually be on balance sheet? What is the real level of indebtedness?

Clause 1 sets out the income tax rates for the forthcoming year, which are unchanged on last year, although one would have been hard pressed to identify that fact from the comments of the Chief Secretary or the Budget speech itself, in which the Chancellor laid
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out his personal tax-raising agenda, which will take £16 billion from 2008-09 and 2009-10 from the removal of the 10 per cent. rate and a further £2.5 billion from changes to national insurance contributions. It has been calculated that those changes will cost 52 per cent. of the employed in Kirkcaldy and Cowdenbeath, the Chancellor’s own constituency, an increasing tax bill every month.

These damaging personal tax-raising changes do not come into being until next year and thereafter, but the reduction in the main rate of corporation tax, from 30 to 28 per cent., does and that is welcome. Unfortunately, the following years will also see rather brutal changes to the general plant and machinery capital allowances, and those allowances must be taken alongside the welcome reduction of the 30 per cent. rate. Between 2008-09 and 2009-10, at £3.76 billion, the changes to plant and machinery allowances alone will bring in more revenue than the £3.6 billion in corporation tax reductions. Furthermore, the increase in clause 3 in the small companies rate to 22 per cent. will generate £1.2 billion over the next three years. Therefore, this Bill, which paves the way for the entire Budget, will see a massive hike in business taxes.

Those business tax rises will do nothing to enhance competitiveness, an issue that has been touched on by many Members in the debate, and that matters particularly in Scotland. We have had a 25-year growth gap. Since 1980, growth in Scotland has been 1.8 per cent. on average as against 2.3 per cent. in the UK. Since Labour came to power, the situation has got worse with 2 per cent. average growth in Scotland compared with 2.8 per cent. for the UK as a whole. That means a 30 per cent. growth gap over time. The additional business tax burdens in the Budget and paved for by this Bill will simply make matters worse. Tellingly, the new annual investment allowance, the research and development tax credit increase and the small and medium-sized enterprise tax credit increase will not kick in until the following year. As ever, with this Government, it is jam tomorrow.

Clause 49, on the definition of a small and medium-sized enterprise, will allow only a few hundred companies in Scotland with between 250 and 500 employees to benefit. There are 265,000 businesses in Scotland, and the vast majority of them are very small, but they create 51 per cent. of all of the jobs and they generate 41 per cent. of all revenue in the country. However, 98 per cent. of those businesses have up to 49 employees; 1.3 per cent. have between 50 and 249 employees; and 0.85 per cent., which comes to about 2,000 businesses, have more than 250 employees. We know that 1,500-odd companies have more than 500 employers, so barely a few hundred of the 265,000 companies will benefit from the allowances announced with such a flourish in the Budget speech.

Clause 12 deals with the air passenger duty. It is expected to raise an extraordinary £3.3 billion over the next three years yet it is likely to deliver little of the stated benefit of a significant reduction in airborne carbon emissions, not least because it applies only to flights originating and ending in the UK. Of course something must be done, but I am not sure that it is this. Moreover, the measure takes no account of the lifeline services to remote rural and in particular island communities, whose businesses are almost wholly dependent on vital lifeline air services.


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