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we can only hope that the Treasury will draw appropriate lessons from this unfortunate experience.
However, I question whether the lesson has actually been learned. For several years now, the reaction to the Chancellors treatment of small business taxation has been dominated by one image: the U-turn. For a little variety, last year I dubbed the abolition of the non-corporate distribution rate a three-point turn. This year, it has become even clearer that the Chancellor is simply going round in circles.
However, my real concern is that providing incentives to small business is no longer front and centre in the Treasurys strategy, and that the emphasis has now shifted on to deciding whether using a tax incentive constitutes avoidance. It all comes back to the Chancellors nebulous reasoning about what constitutes a fair and appropriate share of tax, or simply the right amount of tax. This is an unfocused way of looking at the broader issue of what small businesses contribute to the economy and what the Government should do to help them. The Paymaster General, unfortunately, she is not with us today, said back in 2004, in the middle of the long-winded debacle surrounding the small companies rate, that
The deliberate and cumulative aim is to underpin all the measures that the Government have taken to encourage businesses to grow and to be more enterprising and productive in the medium and long term and not to operate year by year by playing around with the tax system.[ Official Report, 27 April 2004; Vol. 420, c. 846.]
However, we would be forgiven for thinking that there is something wrong with the Treasurys deliberation, and that its policies have not been cumulative at all. Certainty and continuity in the tax system are helpful to all businesses but particularly small ones, which have less capacity to adapt quickly or take specialist tax advice. The rate changes and forthcoming proposals for a new annual investment allowance only deepen the artificial gulf between small businesses and larger firms.
The Chancellor has in fact taken the muddle of the small companies rate and created a paradox. Reducing the main rate of corporation tax and capital allowances leads to a cut in the tax rate and to an increase in the tax base for larger businesses. However, small businesses are being pulled in the opposite direction through an increase in the tax rate and a narrowing of the tax base, because fewer businesses will be able to make full use of the new investment allowances of which we have heard much during this afternoons debate. The Chancellor has made the fatal assumption that because all small businesses, in whatever sector, will theoretically be able to make use of the investment allowance, all will do so. That was the justification he gave to my hon. Friend the Member for Gosport (Peter Viggers) during the Treasury Committees inquiry. The Chancellor also defended the changes on the grounds that they appear to be revenue-neutralperhaps that is just another example of a tax cut being a tax con. However, even if we are inclined to accept that reasoning, the AIA will not take effect until next year, leaving a guaranteed tax rise over the next year.
I want to probe behind the modelling that led to the assumption of revenue neutrality and establish exactly how many of the UKs 1.3 million incorporated businesses are expected to make use of the allowance and to what extent. Perhaps the information will be forthcoming later when the Minister responds to the debate.
Rob Marris: The hon. Gentleman talked about phasing in the allowance, but he also said that there would be a tax rise this year. He is right, but we need to keep things in perspective. My understanding is that the tax rise will be the relativelyI stress that wordsmall amount of £10 million a year, which is only £2 per small business.
Mr. Newmark: I always appreciate the hon. Gentlemans interventions, but small businesses operate on the margins so £1,000even £500can make a huge difference. Unfortunately, the provision demonstrates yet again the Labour Governments lack of understanding of how small businesses actually work and survive from day to day.
I am only hazarding a guess, but if too many businesses make use of the annual investment allowance they could sow the seeds of the Governments next anti-avoidance strategy. Businesses that invest will come to be seen as cheating. In the words of the Federation of Small Businesses:
It is amazing how quickly a concession to encourage enterprise can become a loophole.
It is not clear whether measures such as the increase in the R&D tax credit and the introduction of the Annual Investment Allowance will have the desired beneficial impact on investment levels by small companies.
I would go a little further. If the Government are looking for a positive signal to send to small businesses, and for a policy that will have no new unintended consequences, there is one simple answer: leave the small companies rate well alone for a year or so and let small businesses and their accountants catch their breath.
Mr. Gauke: I, too, oppose clause 3 for the reasons outlined by earlier speakers, but I want to explore the Governments thinking a little further and ask some questions about their approach to the small corporation tax rate.
As the hon. Member for Bishop Auckland (Helen Goodman) said, there is an issue about the two different tax regimes that may apply to a small business. As my hon. Friend the Member for Fareham (Mr. Hoban) said, if the business can be taxed as income, it will pay income tax and national insurance contributions, whereas if it is taxed as a company, it will pay corporation tax, so there can be distortions, as I would be the first to acknowledge. However, I am curious about whether the Governments approach, as outlined in clause 3, is to make the system as tax-neutral as possible and to remove any distortionif that is the right wordbetween the two systems. If so, there are a number of further questions.
Do the Government acknowledge that their previous approach to the zero rate of corporation tax was wrong? It undoubtedly created an incentive for small businesses to incorporate and there was a substantial increase in incorporations. In 2001, 220,000 companies were incorporated; by 2003, the number had risen to 397,000. Undoubtedly, the zero rate of corporation tax contributed to that. As to the point made by the hon. Member for Wolverhampton, South-West (Rob Marris) in an earlier intervention about the need to disaggregate incorporations between companies and limited liability partnerships, I happen to have the numbers to hand. In fact, limited liability partnerships have made a very small contribution. In 2005-06, there were 6,570 incorporations for LLPs, whereas there were 372,000 for limited companies. Clearly, LLPs are not a substantially large part of it. The tax system has undoubtedly contributed to that position.
If it were the Governments intention to take away any tax advantage from incorporation vis-Ã -vis non-incorporation, their approach has been incoherent. Let us consider this Budget alone, where changes to national insurance contributions and higher rate thresholds for income tax further encouraged businesses to incorporate. There is a larger and wider standard rate of income tax and no additional income tax to be paid on dividends within the rate, yet national insurance contributions now cover a larger area, which is where the advantage lies. The hon. Member for
Twickenham (Dr. Cable) raised the matter of aligning corporation tax with income tax, but there is still a difference with national insurance contributionsa problem that has got worse as a consequence of the Budget. There appears to be an incoherence in the Governments approach.
A number of hon. Members, and particularly my hon. Friend the Member for Sevenoaks (Mr. Fallon), dealt with businesses that fall outside the various permitted reliefs and allowances. Again, I question Government thinking in this area. When they introduced the zero rate band, they argued that it would encourage growth and entrepreneurial spirit, which are commendable. They then scrapped the zero rate band because it was over-used. The argument may be that it was used by businesses that were not looking for growth and a more entrepreneurial approach.
Are the Government saying that the only small businesses likely to grow to create jobs and become entrepreneurial businesses are those that can use the capital allowances? If so, that seems to be entirely misconceived. It is not possible to identify a particular type of small business that is likely to be high growth. It simply does not work like that, because many service industries or high-technology businesses might not require great capital investment, but they could still be the big employers of the future. It seems to me that the Government are adopting a rough-and-ready approach to addressing this particular concern.
My final point concerns the bureaucracy imposed on small businesses. My hon. Friend the Member for Fareham mentioned that research and development credit take-up tends to be very low. The reason is undoubtedly that it is difficult to claim, complicated and requires a great deal of effort. Inevitably, small businesses are not in as strong a position to respond as larger businesses. Providing greater allowances that are often hard to claim is not an adequate way of trying to mitigate the increase in tax rates. Whatever way one looks at it, it is not good for small businesses. I am afraid that pointing to the existence of those allowancesI appreciate why we cannot dwell on this particular pointamounts to a poor argument.
I am conscious that the debate on clause 3 has gone on for some time and I do not intend to prolong it unduly. I will just reiterate some of the points that have been made by other hon. Members. In the context of one of the Budgets declared aims, the Finance Bill provides clear evidence that the Chancellor seeks to impose a regime for small and medium-sized businesses that is not good for business. The regime is prohibitive for business. It will restrain and restrict business from generating the profits that it needs to reinvest by increasing the taxation take to the Chancellorto the public purse. Essentially, the corporation tax increase for small business is funding the corporation tax cut for large business, but when taken in the round with the other measuresI will not try your patience any longer by straying from the
clause, Sir Alanthe burden on business as a whole is significantly increased. That is a result of the clause and other measures in the Bill, and other measures outside the Bill that will have a significant impact on individual businesses.
Let us consider the Chancellors claim to be a business-friendly Chancellor after 10 years, given that he has introduced a taxation regime that, as we have heard from other speakers in the debate, has involved a complete volte-face. We have had measures to encourage the incorporation of businesses and now we have measures to discourage the incorporation of businesses. Businesses look for stability in tax planning. Many investment decisionsincluding those that I am not able to refer torequire some understanding or expectation that the tax regime will have stability for a number of years so that businesses can take advantage of the measures that give those opportunities. If the tax regime is tinkered with to the degree that it has been by this Chancellorso frequently; year in, year outthe stability is not there, making those decisions becomes increasingly difficult, and there is a lack of trust in the conduct of taxation policy. I am afraid that this Finance Bill helps to stoke up that lack of trust.
My hon. Friend the Member for Fareham (Mr. Hoban) and other hon. Members have quoted some of the public responses to the measures and to this clause in particular. One response that struck meI do not think that it has been mentioned so farcame from a survey conducted by the Forum of Private Business on its website. Some 82 per cent. of respondents to the survey felt that the corporation tax hike for small businesses would be damaging to their business. The Financial Secretary cannot ignore that statistic. I look forward to his response when he sums up.
Mr. Colin Breed (South-East Cornwall) (LD): I want to build on some of the remarks made by my hon. Friend the Member for Falmouth and Camborne (Julia Goldsworthy). Cornwall was fortunateif we look at it one wayin achieving objective 1 status a few years ago. On the back of that, we had the wonderful opportunity to develop the combined universities in Cornwall to try to build some of the knowledge base and future GDP of the county, and to build up the economy. Much of that was going to be centred around relatively fledgling businesses in new knowledge-based industries, such as renewable energy, IT consultancy and marketing. Many of those small businesses have just started. They really are fledgling in that sense. Their business plans would have been predicated on certain assumptions about the tax that the businesses would be paying.
Those businesses are perhaps two or three years old now. They are not capital-intensive businesses, but they tend to want to employ relatively expensive new personnel. When new personnel come into a company, they are not immediately productive, but, of course, their salaries and their expenses have to be paid out by the company. Some of the small businesses are going to begin to stutter a little when it comes to their ability to fund some of that revenue, which would have been thought to come from the profits that they would initially begin to generate. That will no longer be the case, because some of that money will have to be paid in tax.
It is part of the issue about stability that when people are looking to create their business plans and looking to the quite considerable growth of these sorts of businesses, they consider the expenses that they will have to pay. Tax is one such expense. They would undoubtedly have made their business plans on the basis that they would not be paying tax quite as quickly as they are now going to be. I think that that will stunt some potential growth and undermine investment from European objective 1 funding. The investments new guise of convergence funding is even more tilted towards such businesses, rather than the old capital-intensive businesses. That funding is designed to generate more knowledge-based industries. If we are to have this new tax regime, the real benefit of boosting the economy of Cornwall, which is the essence of convergence funding, will be undermined.
Rob Marris: What a fascinating debate. I understand why Conservative Members have spent a lot of time on this because small business is important. They talk about damage to competitiveness, yet they also say, quite properly, that the changes will largely affect service companies, which make up 75 per cent. of the small business economy. I suspect that few small service companies export much, so the competitors are medium-sized and big companies. It is surprising, given what Conservative Members have said, that the Conservative party is turning against big and medium-sized business, putting forward a positively Poujadist approach and making a fetish of small businesses.
Mr. Hoban: It is somewhat extraordinary that the hon. Gentleman is arguing that service businesses, especially small service businesses, tend not to export. Several small service businesses in my constituency export a great deal overseas. The measure will thus have an impact on their competitiveness. He needs to be careful about the assertions that he is making about the propensity of small businesses to export.
Rob Marris: In one sense, the hon. Gentleman might be right, but, in another sense, he is completely wrong. A small business cannot export a great deal because, of course, it would therefore not be a small business. However, such a business might export a large proportion of its output. I was careful to say that I suspect that most small businesses in the service sector do not export a great deal.
During the interesting remarks made by the hon. Member for Sevenoaks (Mr. Fallon), he used the adjective distortive, which was a new word to me. I entirely reject the approach to economics that he cited, which is based on a view that is peddled by academic economists of the worst sort: that there is such a thing as a perfect market and that that perfect market can thus be distorted. If one rejects the notion that there is such a thing as a perfect market, as I do, there is no such thing as distortion in this context, although there is such a thing as changed behaviour, or certain effects stemming from certain causes.
Changed behaviour that is driven by a tax regime is nothing new in the United Kingdom. It is often the subject of considerable debate on financial measures relating to green taxes. If the Chancellor proposes
fiscal measures to encourage a change in behaviour, that is not wrong in principle, although hon. Members might think that the measures will not produce the desired effect, or that the effect that the Chancellor is trying to achieve is not one that they desire. However, I reject the suggestionthis has been the flavour of part of the debatethat the fiscal measures to change behaviour that are proposed in the clause are somehow, in and of themselves, bad things.
Mr. Newmark: I have two questions for the hon. Gentleman. First, how will it be possible for a service companythe majority of small businesses are service companiesthat is not capital intensive to change its behaviour under the scheme? Secondly, why are manufacturing or capital-intensive businesses any more deserving of tax incentives than those in the service sector?
Rob Marris: I can deal with the second point. As a Member for a west midlands constituency, I am aware that the vast majority of UK exports come from the manufacturing sector and not from the service sector. Important as the service sector might be to exports, about 56 per cent. of the value of exports comes from manufacturing.
Rob Marris: No, it is responsible for invisibles; as the hon. Lady should know [Interruption.] They are not exports but invisibles, which are a different category in economic terms. Although they go on the balance of payments, they do not go on the balance of trade, so I stand by what I said in response to the hon. Member for Braintree (Mr. Newmark). He asked why manufacturing should have special support, and that is one reason I give him. He might not like it, but I stand by it: the majority of exports in terms of the balance of trade come from manufacturing.
I shall come on to the hon. Gentlemans first point about manufacturing. The hon. Member for Sevenoaks cited comments made by Mr. Whiting. He is quoted in the Treasury Committee report as saying words to the effect that most businesses prefer simpler and lower taxesI hope that he will forgive me for not having the exact wording before me, although that was broadly what he said, and I believe that he used those two adjectives. I am sure that they do. I have no direct evidence for that, other than anecdotal evidence gained from talking to business people.
The evidence is plain for all to see that in the United Kingdom for the past 100 years, until recentlyeven now the situation has not changed enoughas a generalisation, there has been huge underinvestment by businesses, be that in the service sector or in the manufacturing sector. I stress that that is a generalisation. It is one thing that has led to weak economic performance in the United Kingdom from the turn of the previous century for the following 90 or 100 years. Encouraging changes of behaviour that will lead to greater investment is a good thing. I share that desired aim of the Chancellor, as I suspect does the hon. Member for Sevenoaks.
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