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“It is a bizarre form of socialism which leaves the rich virtually unaffected but hits the poorest the hardest”.
I do not want to presage too much of tonight’s debate, so I should make it clear that he was writing in 2004 about the introduction of the minimum 19 per cent. rate for non-corporate distributions. The comparison between that and other poorly timed simplifications with disproportionate effects bears noting, and we should not forget that the increase in the small companies rate came in very handy when the Prime Minister was trying to balance the books after he cut the main rate from 30 to 28 per cent. as part of his pre-election stunt.
The proposals in clause 5 are at least part of a three-year escalation and businesses can be grateful that they have been given a time line for increases in their further tax burdens, but we are still talking about tax increases. I speak in favour of amendments Nos. 1 and 2 in the hope that the Government will think again about committing to escalating the small companies rate to 22 per cent. by next year. The original decision was made both in more benign economic conditions than those today and by a different Chancellor.
What is more, the Government have shown in the past few months that they have a firm track record in only one respect: the rapid reversal of fiscal policy. I hope that I can encourage the Minister to think again, if only because the third time is the charm, and to come back to the House on Report with a small companies rate that does not increase the burdens falling on small businesses that are ill equipped to deal with them. If the Government are looking to do something that might restore the trust of the small business community, they need look no further than a freeze on the current rate and a moratorium on fresh uncertainties.
4.30 pm
The Financial Secretary to the Treasury (Jane Kennedy):
It has been an interesting debate to warm us up for later proceedings. The right hon. Member for
Wokingham (Mr. Redwood) lumped this proposal with others and described it as a stealth tax. It is not so stealthy that hon. Members are not protesting against it, as witnessed by this debate. I have noted the fact that the Opposition voted against this measure in the Budget.
The hon. Member for Fareham (Mr. Hoban), in his opening comments, moved quickly to the differences between us. It is interesting that his right hon. Friend the Member for Witney (Mr. Cameron) was quoted as saying that people should
“never believe a politician about tax or borrowing, unless they are prepared to take tough decisions about public spending.”
I see the hon. Gentleman nodding in agreement, and I shall return to that comment in my closing remarks. In the mean time, I invite the Committee to consider it.
The Government announced changes in last year’s Budget to encourage investment and innovation. The small companies rate of corporation tax remains highly competitive internationally and has by far the highest threshold in the G7 at £300,000—a fact that one would hope would be welcomed. The average threshold for other G7 members with a small companies rate is just over £23,000.
If I may, Sir Alan, I will stray slightly wide—although not, of course, wide of the amendments—in responding to some of the criticisms that have been levelled at the Government and in explaining our proposals and why we seek to resist the amendments. The World Economic Forum ranks the UK as one of the top 10 most competitive countries, ahead of France, Canada and Australia, and the World Bank ranks the UK sixth in the world in doing business, ahead of Germany, France and Japan. We are also first in the G7 for ease of paying taxes, which is an important factor for small businesses. The Government are committed to tax simplification and have announced a package of more than 20 measures, including simplification of the associated companies rules and a new review of CT calculations for small businesses, all of which have been welcomed by small and medium enterprises.
I welcome the hon. Member for Taunton (Mr. Browne) and his L-plates—I have great sympathy for some of the comments that he made on that score. He stated that the UK tax system imposes significant burdens on small businesses compared with other countries. I do not accept that statement. At the Budget 2008, Her Majesty’s Revenue and Customs published details of how it is improving services for small businesses, including progress against its administrative burden reduction targets. According to the PricewaterhouseCoopers World Bank publication “Paying taxes 2008: The global picture”, a standard UK company spends less time complying with the tax system than a similar company in any other G7 country. The Government have outlined in their enterprise strategy, published at Budget 2008, how they will build on their targeted net reduction in the administrative burden of regulation by 25 per cent. by 2010. It is therefore wrong to claim that the changes to the small companies rate of corporation tax affect all businesses.
The UK has around 4.4 million small businesses. Of those, 75 per cent. are the self-employed, and they are not affected by the changes to the small companies rate of corporation tax. Additionally, about 400,000 companies
pay no corporation tax, so they will not be affected by changes to corporation tax rates. Of those companies that pay corporation tax, a quarter of large companies and more than half of medium-sized companies pay tax at the small companies rate. It is important to realise that the rate is in fact a small profits rate. Any company with profits up to £300,000 benefits from that low corporation tax rate, regardless of its size.
Both groups can benefit from one of the other changes in the Bill: the annual investment allowance for expenditure up to £50,000, which has been maligned by Opposition Members. Both the hon. Member for Hoban— [ Interruption. ] I apologise to the hon. Member for Fareham; that is why I increasingly need my reading glasses. The hon. Members for Fareham and for Dundee, East (Stewart Hosie) said that the AIA did not go far enough. The hon. Member for Dundee, East in particular, speaking for the Scottish National party, criticised the AIA’s ability to help with the costs of training staff, improving staff capability and other intangible investments. I am sure that he knows this, but it is worth bearing in mind the fact that the cost of employees can already be offset against tax. The AIA will allow businesses to offset £50,000 of capital expenditure in a similar way.
The Government are expanding and improving Train to Gain, with funding rising to £1 billion by 2010-11. The other forms of investment mentioned by the hon. Gentleman are directly deductible for tax purposes. Indeed, the Government have introduced a generous research and development tax credit, which was picked up on by other speakers, that provides more than 100 per cent. relief—it provides 150 per cent. relief against tax for small companies.
In debating the amendments, it is necessary to understand the changes to small business taxation in a wider context. The Government have lowered corporation tax rates for small companies over the years in order to encourage investment. We have reduced the small companies rate from 23 to 19 per cent. and introduced a starting rate of corporation tax for those with profits below £10,000.
Those lower rates of tax resulted in a significant number of people incorporating, not to invest and reinvest in their businesses but simply to extract the profits in a way that reduces their personal tax and national insurance contribution liabilities. I shall not quarrel with the point made by the hon. Member for Fareham that we were warned of that at the time, but those who take such action carry out the same economic activity as they did before they incorporated but pay lower rates of tax than those who remain unincorporated and than employees.
Such people are not using incorporation as a launch pad for growth. Instead of concentrating on their core business and being advised on how to expand and become more profitable, they and their advisers are treating incorporation as a tax break, which is being subsidised by ordinary taxpayers and the self-employed businesses that suffer a competitive disadvantage. The increase in the small companies rate will reduce the differential in tax paid between the incorporated and the self-employed.
Mr. Hoban:
The Financial Secretary’s arguments are reminiscent of those used by her predecessor in the debate last year. It is almost a Yogi Berra moment; it is
déjà vu all over again. What research has the Treasury done to prove what proportion of companies incorporate to take advantage of the 0 per cent. corporation tax rate? Are companies continuing to use that despite the fact that the 0 per cent. rate was scrapped?
Jane Kennedy: It is too early to say what the total impact of last year’s proposals will be. I shall commission work to answer the hon. Gentleman’s point, and when I have that sort of detail, I shall communicate it to him. I am sure that we will have the opportunity to return to the subject in the Public Bill Committee in a few days’ time.
Mr. Redwood: Does the Financial Secretary not accept that someone who had incorporated in order to take advantage of the lower tax rate would have to pay full income tax if they wished to pay themselves a higher salary or dividends after profit?
Jane Kennedy: The difference in the tax burden for those who are incorporated and those who are unincorporated is clear and accepted, and our proposals have been phased in, to allow companies to take those changes into account, and to recreate, as it were, a fair and level playing field between small businesses competing in the same sector that may not be incorporated for tax purposes. The increase in the small companies rate reduces the differential between the incorporated and the self-employed. That means that the 3.3 million unincorporated businesses will be relatively more competitive—thus, as I said, levelling the playing field.
Last year, we announced a package of business tax reforms to improve competitiveness and encourage investment and growth. The changes to the small companies rate are part of that package, which refocuses the incentives for small businesses on the activity of investment, and is designed to promote fairness across all 4.4 million small businesses. The hon. Member for Fareham asked why a targeted solution to the tax-motivated incorporation problem was not adopted instead of increasing the small companies rate. We have done extensive work on the issue of small business taxation, balancing incentives for small business growth with fairness in the tax system for all, and the changes to the taxation of small businesses announced in the Budget last year provide a good balance between those objectives.
It would be wrong, however, to consider the small companies rate in isolation, and the change in that rate was only one component of the small businesses package announced in the 2007 Budget. That package refocuses the manner in which the Government provide incentives for small businesses on the activity of investment, and it would be wrong, as I have said, to take it in isolation.
Mr. Newmark: We face difficult economic times, and I am trying to understand the logic of increasing taxation in a period that is particularly difficult for small businesses. How does that provide them with an incentive to continue to grow their business, and what have we done to encourage businesses to come and set up in this country, as they can actually see that business has increased year in, year out? [ Interruption. ]
Jane Kennedy: My hon. Friend the Exchequer Secretary reminds me that a figure of 700,000 new businesses is not a discouraging one. The hon. Member for Braintree (Mr. Newmark) asked me a general question about the economic climate in which we have made these changes. As I have just explained, they are intended to re-establish fair competition for those who have been incorporated for tax purposes, and thus enable them to take advantage of arrangements that ought to have been made for investment in business for growth purposes. By levelling the playing field, we will restore the motivation for companies to focus less on how to use incorporation to avoid tax liabilities, and encourage them instead to focus on growing their business.
The annual investment allowance, as I have mentioned, will target assistance directly on those businesses that invest their profits, regardless of their legal form. It will be available to all 4.4 million businesses, and will allow them to offset up to £50,000 of capital expenditure in the same way as they offset other costs such as employment costs. To increase the sense of déjà vu experienced by the hon. Member for Fareham, I repeat that the package is important: it was introduced last year, and it is part of the ongoing debate. Simon Sweetman, chair of the Federation of Small Businesses tax committee, said:
“The Annual Investment Allowance will be significant for small business, both incorporated and unincorporated...and has the added benefit of being a simplification.”
The allowance should be welcomed, rather than dismissed as some speakers have done.
The Government also announced an increase in the small and medium enterprise R and D tax credit rate from 150 per cent. to 175 per cent.—we will come on to debate that later in other clauses—and that will also help small companies investing in new technology. All these measures taken together refocus tax support on investment rather than on low profits.
4.45 pm
Thank you for bearing with me, Sir Alan. I will now deal with the proposed amendments in detail and in turn. I fear that the amendments would pose a serious risk to fairness. The Government have set out how they will make the tax system fairer across all small businesses, reducing the competitive disadvantage, as I have said, faced by unincorporated businesses. However, the Opposition believe that all 3.3 million of them should continue to be disadvantaged in this way.
Amendment No. 1 would encourage further tax-motivated incorporation, counteracting the moves towards fairness that the Government support. Furthermore, the small companies rate will still be lower than it was in 1997 when it was 23 per cent., even as we take the proposals forward.
Amendment No. 2 proposes to maintain the current fraction of marginal relief as 1/40th. In proposing the amendment however, the Opposition have not done their sums properly, setting out a perverse incentive to have profits within the marginal relief band. The fraction for marginal relief ensures that there is a smooth rise in the rate of tax applied to companies with profits between the thresholds for the small companies and main rates of corporation tax. In proposing that the small companies rate and marginal fraction both be maintained at last
year’s level, the Opposition fail to take account of the reduction in the main rate of corporation tax from 30 to 28 per cent.
Mr. Redwood: Will the Minister explain how it came to pass that the previous Chancellor created such an unfair system in her view that the Government now have to amend it in this direction of creating greater fairness? Is it not rather the case that the previous Chancellor gave a poisoned pill to his successor in the form of higher taxes across the piece?
Jane Kennedy: As I have said, and as the right hon. Gentleman will remember, the intention of the changes that have led to advice given by tax advisers to incorporate to avoid tax was to encourage investment and growth, particularly in small businesses. We are now correcting an imbalance that has developed as a result of the behaviour in response to those changes.
As I have said, the amendment would negate the purpose of marginal small companies relief. By way of illustration, if the Committee were to accept the amendment, a company making profits of £301,000 would pay more than £5,500 less in tax than a company making profits of only £299,000. It would do nothing to benefit the vast majority of small businesses in the UK.
Amendment No. 7 proposes that an assessment of the impact of the changes to the small companies rate should be undertaken before any change is made. Again, it shows that Opposition Members misunderstand the changes put forward by the Government, which are about improving competitiveness across all small businesses. Reducing the differential in tax between the unincorporated and incorporated will allow better direct competition. Delaying implementation of this change will allow the differential to remain. Furthermore, the changes to the small companies rate are part of a wider package that encourages all businesses to invest and innovate to assist future growth. The introduction of the annual investment allowance benefits all businesses, allowing them to compete more fairly.
It is appropriate that I should make clear the substantial fiscal risk that the amendments pose. Together, they would cost the Exchequer more than £300 million next year. That brings me back to the statement by the right hon. Member for Witney that I quoted earlier. The Committee should consider the amendments in the context of the fact that the main Opposition party voted against all the revenue-raising measures proposed in the 2008 Budget. Given that the country is looking for a Government who are wedded to economic responsibility, I do not believe that such amendments should be accepted. They would do nothing for the majority of small businesses and fail to recognise the importance of fairness across the board in the tax system.
I would ask the hon. Member for Fareham to withdraw the amendment; however, having heard his opening speech, I am clear that he is unlikely to do so. In that case, I ask the Committee to resist the amendments.
Mr. Hoban:
First, I want to say something to the hon. Member for Taunton (Mr. Browne), who, to use the words of the Minister, has his L-plates on. Thinking back to the hon. Gentleman’s reference to an
obituary of Humphrey Lyttelton, I should say that tax is rather like the game Mornington Crescent: the rules are there if we look carefully, and they will become discernible apparently.
I take issue with the introduction and conclusion of the Minister’s speech; they were written without the arguments for the amendments having been heard. It was clear from what I said that our proposed cut in the small companies rate of corporation tax would be funded through the scrapping of the annual investment allowance. We have made that clear, not only today but in debates earlier this year and around the time of the Budget. We believe fundamentally that by restructuring the current allowances and reliefs we can make savings that would pay for reductions in the main and small companies rate of corporation tax. We are proposing a funded tax cut.
On several occasions, the Minister came back to the point that the Government’s measure was to tackle what she claimed was an unfairness in the tax system which encouraged incorporation. Yet at the same time, as the Minister said in response to an intervention of mine, the Government have not done the work to understand whether last year’s scrapping of the 0 per cent. rate was sufficient to discourage tax motivated incorporation. She further undermined her arguments by highlighting that larger businesses would also be affected by the tax increase. She referred to the proportions of larger and medium-sized companies that also paid the small companies rate of corporation tax.
If we look at the rate of incorporation for companies in the past six years, yes, we see that there has been a 50 per cent. increase in the number of companies incorporating with only one employee. Companies with between one and nine employees are running at about 37 or 38 per cent. in that regard, and for those with more than 10 employees, the figure is just under 20 per cent. We are seeing significant increases in the incorporation of companies of all sizes. Given the long tail of owner-managed businesses, with no employees, that I see in my constituency, perhaps it is not surprising that a large number of them incorporate.
The Government’s measure is meant to deal with the issue of fairness, but it imposes an additional tax burden on small companies at a time when they do not need it—they are struggling with higher costs and economic uncertainty. I will press amendment No. 1 to a Division because of the problems that face small companies. They want a Government who are on their side and are not working against them. By increasing the small companies rate of tax from 19 to 23 per cent., the Government are damaging those businesses when they need help and support. Conservative Members and, I believe, other Opposition Members recognise the importance of supporting small companies. I hope that those Opposition Members will back us in the Division Lobby.
Question put, That the amendment be made:—
The Committee proceeded to a Division.
The Chairman: Order. I ask the Serjeant at Arms to investigate the delay in the No Lobby.
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