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“why the Government chose to use a blunt instrument impacting on all small businesses rather than focussing their resources on targeting those who are using Managed-Service Companies as a front for tax avoidance”.
There is a serious doubt in the small business community, therefore, about whether tax-motivated incorporation still persists as an issue and, if it does, whether raising the small business rate of corporation tax is the way to tackle it, as there may be other ways of doing so.
The Chancellor sold the package to small businesses because of the offsetting tax changes, such as the extension of the 50 per cent. first year capital allowance for this year and the changes in subsequent years, and the changes in the research and development tax credit. It is worth remembering the impact that such change will have on the profitability of businesses and their ability to invest for the future. In its comment on the Budget, the Association of Convenience Stores pointed out that
“convenience stores generally operate on a 1 to 2 per cent. net profit margin, and the increase in the rate of corporation tax on small business will further erode this.”
How on earth will they find the profits to survive as a business and create new earnings for the owners and shareholders, and will they be able to retain sufficient profits to enable them to grow and develop in the future?
Many service sector companies will face that problem as a consequence of the change. I am not sure that they will benefit from the more generous capital allowances or the changes to the research and development tax credit. For many service sector companies, investment on such a scale is rare, and the Government should remember the importance of the service sector to the economy as a whole. As I said earlier, about 75 per cent. of the economy is accounted for by the service sector, so if the Government start to attack that sector and restrict its ability to grow and develop, they are creating a long-term problem.
We can all identify service companies in our own constituencies that might not benefit from the change, such as hairdressers or caterers. Let us take a business that I know—a conference business run by a friend of mine. It does not need to invest very much in physical assets, but its retained profits are necessary to provide the capital to expand the business and generate the money that can be used to take risks in growing the business. Service sector businesses will be worse off as a consequence of the Budget. They will suffer the tax rise, but they will not be eligible for the reliefs that the Chancellor increased in the Budget.
One argument for the tax increase is that it will tackle tax-motivated incorporation. The other argument deployed by the Chancellor is that there will be other moves to compensate for that. When we consider clause 3 in the round, we should remember the arguments put by the Chancellor. It is important to remember that the changes to capital allowances are a timing difference. Capital allowances change the phasing of permissible capital expenditure for taxation. Increasing the first year allowances accelerates the tax relief; it does not increase the amount available for tax relief over the lifetime of the asset. It is a timing difference, not a tax cut.
Victor Dauppe, a tax principal at MacIntyre Hudson, was right when he said:
“Extra corporation tax is permanent, and the increased capital allowances are either temporary, not yet in place or unavailable for some companies.”
The Financial Secretary to the Treasury agreed with that. In last week’s Second Reading debate he said that
“the changes to capital allowances have a largely temporary timing effect”.—[ Official Report, 23 April 2007; Vol. 459, c. 758.]
That indicates the deal that is on offer to small companies. They see a permanent increase in their rate of corporation tax which is offset—if they are eligible to make a claim—by a temporary short-term timing difference that improves their cash flow today, but is reversed later.
Stewart Hosie (Dundee, East) (SNP): The hon. Gentleman is right to say that the additional tax take may erode small companies’ ability to invest. He is also right to suggest that many of them will not be eligible for some of the existing reliefs. The changes this year and in the following two years will take £1.2 billion in additional revenue, and perhaps £100 million out of Scottish business. What impact does he think that will have on the 98 per cent. of Scottish businesses that employ fewer than 50 people, but which generate 41 per cent. of all revenue in Scotland? What impact does he think £100 million of their profits will have on their ability to invest in the future?
Mr. Hoban: The hon. Gentleman raises an important point which reflects the issue raised earlier by the hon. Member for Falmouth and Camborne (Julia Goldsworthy) about the regional and national effects that the changes will have. I should have thought that £100 million coming out of the retained profits of Scottish companies would have a significant impact on their ability to develop, expand and grow. We need to be aware of the effect that the change will have on companies up and down the country. It looks as though the hon. Member for Bishop Auckland (Helen Goodman) is ready to intervene—but no, she is just looking very eager and anxious.
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The thing to remember is that every profitable small company will pay the increase in corporation tax, but not every company will qualify for or apply for R and D tax credits or benefit from the changes. Use of the R and D tax reliefs is as low as 11 per cent. A third of companies for which the tax credits were relevant did not claim them, because according to a survey produced by PricewaterhouseCoopers in 2006 the process was perceived as too difficult. The argument that the tax increase is fine because it is offset by reliefs and allowances elsewhere does not hold true if a business feels that the process of claiming the reliefs and allowances is too complex or that they do not apply to it. The Government cannot pretend that improving the reliefs is the answer to the additional tax that they have imposed on small companies; that argument does not wash because of the low take-up and use of these reliefs.
Mr. Philip Dunne (Ludlow) (Con):
Does my hon. Friend agree that small companies may be affected not only by the reliefs that he has just talked about but by the empty property relief—a substantial relief that is not even part of the Finance Bill but which is being restricted significantly, raising nearly £1 billion for the Chancellor? That will also have a disproportionate
effect on small companies that have empty premises, perhaps through no fault of their own but because of default by a subsequent tenant.
Mr. Hoban: My hon. Friend makes a valid and important point about the widespread impact of the Budget on small companies, but I will not be tempted down that route as it falls outside the scope of clause 3. I am sure that his point will be heard by those groups that take a close interest in the matter.
I was talking about the use and take-up of reliefs and their growing complexity. To offset the increase in corporation tax, small companies will have carefully to consider how they can claim R and D tax credits or capital allowances and will have to navigate their way through a complex system. A poll of members of the British Chambers of Commerce said that 69 per cent. believed that business taxes should be streamlined so that taxes were lower overall and so that the system of tax allowances and exemptions was abolished. A large proportion of businesses prefer a simpler, lower tax burden to one with higher rates offset by more generous exemptions and allowances. A survey by the Forum of Private Business showed that tax allowances designed to encourage investment in companies did not appeal to smaller businesses.
The general concern about the take-up rate for the changes to the allowances and the effects that they will have led the Treasury Committee to recommend in its report on the Budget that
“prior to the 2009 Budget, the Treasury review the impact of these measures on business investment in order to ensure that the measures are having a positive impact on investment and business growth, including the impact on small businesses that do not qualify for R and D tax credit or the Annual Investment Allowance.”
Clearly, there is widespread concern about whether the allowances will be taken up. If they are not, small companies will be hit by the increase in the small companies rate of corporation tax.
It is worth considering the impact on small companies of the increase in the small companies rate of corporate taxation. The Red Book estimates that the cost to small businesses in the 2007-08 tax year will be about £10 million; that in 2008-09 it will be £370 million; and that in 2009-10 it will be £820 million. That is a £1.2 billion tax take from small companies. How will that impact on the individual companies that are subject to the regime?
The Financial Secretary said last week on Second Reading that there were about 4.3 million small businesses in this country, that approximately three quarters of those were self-employed and therefore not affected by the increase in corporation tax in the Budget and that, of those that remained, a further quarter did not pay corporation tax because they had no declarable corporation tax profits. That means that approximately 800,000 businesses will be affected. In the 2009-10 tax year, they will pay £820 million. That implies an average increase in corporation tax to those businesses of £1,000 per business.
The Chief Secretary to the Treasury (Mr. Stephen Timms): The hon. Gentleman refers to the table in the Red Book. Will he confirm that the revenue that he described is being recycled back to small businesses through the capital allowance measures?
Mr. Hoban: That assumes that small businesses take up the allowances and reliefs that are available. The Chief Secretary was careful in his choice of words, because all small businesses can claim the increase in allowances, regardless of whether they are incorporated. The average benefit from the increase in allowances is approximately £68 per small business. Small companies will pay on average £1,000 more in corporation tax, but the group of 4.3 million will gain only about £60 a year. That is not a fair deal for small companies. The benefit is being spread rather thinly.
Mr. Newmark: Is not that another example of the Chancellor simply saying, “I’m going to take your taxes and you can claim them back as a business person but only if you do exactly as I say”? It is management by the clunking fist, not the invisible hand of Adam Smith.
Mr. Hoban: My hon. Friend makes an important point. The Chancellor is loading incentives towards a specific sort of business. If businesses invest in research and development and physical assets, the Government will give them some tax relief and allowances, but if they do not, they will not be able to claim the reliefs. A small company will have to pay more tax anyway. The Chancellor penalises small companies and spreads the benefit among all business.
Kitty Ussher (Burnley) (Lab): Is not it the Conservative party’s policy to encourage small businesses to invest, because that will lead to their greater prosperity, productivity and growth? Does not the hon. Gentleman accept that a company with profits of up to £100,000 that invests half the profits will end up paying 40 per cent. less tax than it would without the Bill?
Mr. Hoban: The hon. Lady makes a mistake. She assumes that investment is about the purchase of physical assets that qualify for capital allowances. However, people can invest in their businesses and get them to grow in different ways by recruiting more members of staff and developing the skills of their work force. Investment is not simply about buying machinery. Investment means that companies can grow in a range of ways, not necessarily through the acquisition of physical assets.
That is the problem with the Government’s approach to the Budget. The Chancellor appears to be interested in only a narrow group of companies. He is happy to reward businesses that buy physical assets, but penalises small companies generally through increasing the small companies tax rate. The Budget’s failure is penalising businesses that invest in people rather than machinery, equipment and plant. The hon. Lady should consider the small businesses in her constituency, especially those that do not invest in plant and machinery but want to take a risk by employing new members of staff. They will be hit most hard by the Budget—they will pay the higher rate of small companies taxation but will not receive in return the increase in capital allowances, which, when averaged out across all small businesses, amounts to about £60 per company. That is not much of an incentive, even if the hon. Lady’s argument held water.
That is why the post-Budget survey undertaken by Populus for the British Chambers of Commerce showed that only 17 per cent. of businesses thought that this year’s Budget would improve their competitiveness. That is the reality of the business reaction to the Budget on the ground. The theory that the Chancellor has put forward in the Budget, and which hon. and right hon. Labour Members have put forward, too, does not hold water. Businesses can expand in ways other than investing in fixed capital and assets. Indeed, the Chancellor is penalising those businesses that do not invest in fixed capital and assets, by increasing the small companies rate of taxation.
Mr. Dunne: My hon. Friend may not have heard the Economic Secretary to the Treasury, speaking from a sedentary position, identify research and development as a possible alternative means of securing some benefit from the Budget. The Economic Secretary is of course correct in his assessment that that part of the economy can take advantage of the reliefs. However, he is completely incorrect, in that he ignores the service sector, which my hon. Friend has rightly highlighted. The service sector gains no such benefit from the £50,000 limit, from either R and D relief or capital allowances, yet it is a sector that is growing very fast. Many companies in my constituency are engaged in mail order, for instance. They might invest in a new catalogue or brochure for their customer base, but they will not benefit from either of the reliefs. There are many other examples of companies in the service sector that do not invest in R and D, or in plant and machinery for capital allowances.
The Chairman: Order. I should tell the Committee that I understand the link in the argument between the tax measure that is the subject of clause 3 and the allowances. However, the allowances are referred to more substantially in clauses 36 and 49, which are not due to be taken on the Floor of the House. If the debate extends too far into the question of allowances, it may be that the Chairman will not favour much debate in the Public Bill Committee.
Mr. Hoban: Thank you for your guidance, Sir Alan. You are absolutely right to draw the Committee’s attention to the rather narrow nature of clause 3. I had hoped just to establish the problems inherent in how the offsetting of allowances had been set up, and why they do not justify the increase in the small companies rate of taxation. However, we shall not need to make that point for much longer, as it is a clear deficiency in the Budget, at least to the Opposition.
That brings me to the conclusion of my remarks. By increasing the small companies rate of corporation tax, the Government have sought to address a problem of their own making caused by the introduction of the zero per cent. rate back in 2002. The risks were there at the time. However, the attempt to correct the problems that arose then will mean that all small companies that are profitable will have to pay an increase in corporation tax. In order to tackle the apparent abuse of the Government’s own rules by a small group, all small companies will have to pay higher corporation tax.
Ministers may talk about large groups, but it would interesting to hear just how many businesses the Government think are taking advantage of the system. However, arguing that all small companies should be penalised and that the only way to offset the increase in corporation tax is to focus on extending reliefs and allowances, where there is no guarantee that they will be taken up, is the wrong approach to tackling the issue. Small companies are the backbone of the economy. They play an important role and are an engine of growth in the British economy. My concern is that the tax increase in question will damage the competitiveness of that important sector.
John Healey: I am grateful to the hon. Gentleman for giving way, because I am anxious to put one point to him before he sits down that he has not yet covered. Will he reverse the tax change in clause 3 in future?
Mr. Hoban: I am not going to stand here today and write the Budget of my hon. Friend the Member for Tatton (Mr. Osborne) for 2010. We will bring forward at the appropriate time our own proposals to stimulate the activity of small businesses and to ensure that they continue to act as the engine of economic growth. We now need to focus on the measures before us today. Small businesses up and down the country have acknowledged that this corporation tax increase will have a significant and damaging impact on them, and that it will lead to some of them being unable to expand and to invest in the future. The Chancellor has sought to extract £1.2 billion from them over three years in corporation tax. That is an attack on those companies and it will do untold damage to them. That is why I oppose the measure before us.
The Chairman: Order. I should perhaps mention that, as we are in Committee, the correct form of address to the Chair is not “Mr. Deputy Speaker”. It should either be “Mr. Chairman” or “Sir Alan”. In the spirit of egalitarianism, I favour neither one over the other.
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Helen Goodman (Bishop Auckland) (Lab): I am pleased to take part in this debate, even though I did not have the pleasure and privilege of taking part in the debates on these matters in 2002. I wish to support clause 3. In considering the taxation of small and medium-sized enterprises, any Government will try to balance two factors: the health of the small business sector and the fairness of the tax system. No one here today underestimates the importance of SMEs. According to statistics produced by the Small Business Service in August 2006, 99.9 per cent. of the 4.3 million business enterprises in the UK in 2005 were SMEs, accounting for 59 per cent. of business employment and 51 per cent. of turnover. Clearly, the small business sector is a key source of innovation and enterprise, and it is important that the tax system provides incentives and rewards for those qualities. Of the 4.3 million business enterprises, 2.7 million are sole proprietors and 500,000 are partnerships, which means that only 1.1 million are companies that could possibly be affected by this change.
As well as taking account of the health of the small enterprise sector, we need to protect the revenue base. Tax must be equitable, as between individuals in similar circumstances. Businesses should not be distracted from their real purpose by tax-induced decisions or activities. Conservative Members belong to a party that seems, particularly in the light of the recent remarks of the hon. Member for Fareham (Mr. Hoban), to be anti-tax. Tax seems to be an optional extra for them. The most recent example of this involved Lord Laidlaw, who promised the Lords Appointments Commission that he would domicile himself in the UK in order to pay UK taxes—
The Chairman: Order. The hon. Lady is straying outside the scope of clause 3.
Helen Goodman: I beg your pardon, Sir Alan. I was simply trying to make the point that it is important for the Government to promote a culture of respect for the tax system, and I feel that Conservative Members do not always show the kind of understanding that they would need to have if they were going to run an effective tax system—
The Chairman: Order. That sounds more like a Second Reading point to me.
Helen Goodman: The tax system will work only when the rules are perceived to be fair. People who abuse the small companies rate by moving from unincorporated to incorporated status purely to pay less income tax and avoid paying national insurance contributions are engaging in precisely the kind of tax-induced activity that does not promote a stronger economy or flourishing enterprise. It is completely unfair if some people can lower their tax bill by moving from unincorporated to incorporated status, while Joe Bloggs, who has to pay his tax through PAYE, does not have that opportunity. That is the essential point at issue in this tax change.
The Chancellor of the Exchequer made it clear in his Budget speech in March that he was introducing the change
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