Written evidence submitted by EEF
ABOUT EEF
1. EEF is the representative voice of manufacturing,
engineering and technology-based businesses with a membership
of 6,000 companies employing around 800,000 people. A large part
of its representational work focuses on the issues that make a
difference to the productivity and competitiveness of UK manufacturing,
including investment, innovation and tax issues.
SUMMARY
2. To build a better balanced economy, the
UK needs the right type of growth, built on long-term investments
in innovation, technology and exports. Consequently, the UK needs
a competitive and predictable tax regime that gives the private
sector - including fast growing manufacturers - the long-term
confidence it needs to invest in the UK.
3. At the start of 2010, however, the UK
had a business tax regime - including corporate, personal, environmental
and indirect taxes - that stood in the way of growing a better
balanced economy through long-term investments in innovation,
technology and exports.
4. The government's commitment to reforming
the corporate tax system has been commendable in that it has sought
to provide stability and reduce the corporate tax burden on business.
In practice, however, its reforms have yet to deliver the improvements
to the business tax system needed to drive growth.
5. For example, its "New Approach"
represents a much needed change in how tax policy is developed,
yet the government has got off to a rocky start in implementing
it. In addition, the government has put reforms in silos, focusing
narrowly on individual aspects of corporation tax rather than
looking holistically at business taxation and how tax reform should
support growth.
6. EEF are therefore concerned that the
government's current approach to tax reform risks leaving business
facing a patchwork of reforms in which the whole is significantly
less than the sum of the parts.
7. Consequently, EEF believe that the government's
tax reform agenda is in danger of falling short of the government's
own priorities, and most importantly, what businesses - including
manufacturers - need from the tax system to invest in growth.
8. Government, however, can ensure its tax
reforms support growth through the following actions:
— Commit
to the "New Approach to Tax Policy Making".
Businesses will begin to question the
government's credibility on tax reform if its implementation does
not improve.
— Revisit
reforms that are neither neutral nor efficient. This
includes rethinking planned reforms for capital allowances and
environmental taxes.
— Take
a more holistic approach to business tax reform. Doing
so would help government in its efforts to reduce the cumulative
burden of business taxation and ensure its proposals - such as
on the R&D tax credit and the patent box - make the best use
of Exchequer revenues in terms of supporting broad-based investments
in innovation.
INTRODUCTION
9. The Select Committee's inquiry provides
the ideal opportunity to assess how this government's tax policy
is affecting investment and growth.
10. Private sector growth in 2011 and beyond
will be driven by investments in innovation and new technology
in the UK (see Chart 1). But despite the recovery, many businesses
still perceive too many undue risks around making long-term investments
in the UK.
Chart 1
INNOVATION & CAPITAL INVESTMENT IN UK
IS KEY TO SUCCESS
% of companies citing how strategic priorities
will be met
Source: EEF Shape of British
Industry Survey
11. At the start of 2010, the UK had a business
tax regime - including corporate, personal, environmental and
indirect taxes - that was tilted against manufacturing and stood
in the way of growing a better balanced economy through long-term
investments in innovation, technology and exports.
12. The government's commitment to reforming
the corporate tax system has been commendable in that it has sought
to provide stability and reduce the tax burden on business. In
practice, however, its reforms have yet to deliver the improvements
to the business tax system needed to drive growth.
THE FUNDAMENTALS
OF TAX
POLICY
13. If tax policy is to support growth, government
needs to refocus on competitiveness and predictability, two principles
which provide a real-world context for academic concepts like
neutrality and efficiency.
14. According to academic literature on tax,
a truly neutral tax regime would treat all taxpayers, regardless
of size or sector, the same, while an efficient tax regime should
not artificially distort investment decisions.
15. As noted above, the private sector recovery
and sustainable growth needs to be driven by long-term investments
in new technologies, innovation and exporting. In a global economy,
manufacturers - even small ones - can choose to invest in growth
outside the UK if the tax system remains uncompetitive.
16. Consequently a neutral and efficient tax
regime would be competitive if it reflected modern businesses'
investment cycles and payback periods, recognised the costs and
risks inherent to developing innovations quickly and to scale,
and it provided the stability and predictability needed to confidently
make long-term commitments to the UK.
17. EEF believe that it is possible for the government,
through simple reforms, to create a competitive tax regime for
growth without resorting to special carve outs and tax breaks
that distort investment decision across the economy. Maintaining
neutrality and efficiency across the tax system is essential for
broad-based growth in the UK. Doing so, however, requires the
government to shift from its narrow focus on individual aspects
of corporate tax reform to take a holistic view of how to improve
the competiveness of the business tax system.
18. Consequently, it is important to understand
that the current tax system and the government's proposals for
reform are far from neutral or efficient for businesses planning
for growth, including manufacturers. In fact the tax system is
becoming increasingly tilted against the investments in technology
and innovation that the government believes are critical to private
sector growth.
TAX POLICY
AND THE
RIGHT TYPE
OF GROWTH
19. The tax system, through its various rates,
reliefs and allowances, creates incentives and barriers for businesses
planning for growth. However, the financial crisis and the painful
recession have shown that not all growth is equal. To build a
better balanced economy, the UK needs the right type of growth,
built on long-term investments in innovation, technology and exports.
Consequently, the UK needs a competitive and predictable business
environment - including tax - that gives manufacturers the long-term
confidence to invest in the UK.
20. Manufacturers', however, have concerns about
the UK's business tax regime (as shown in Chart 2 below). Given
this negative view, the government's early commitment to tax reform
has been commendable. The 4p cut in the headline rate of corporation
tax over the next four years sends a strong signal that the UK
wants to create a competitive corporate tax regime. The government's
"New Approach to Tax Policy Making", which is based
on more effective consultation and scrutiny of tax reform proposals,
could improve the quality of legislation and reduce the likelihood
of unintended consequences. Similarly, the government's broad
road map for reforming corporation taxes underscores its commitment
to improving predictability for businesses making long-term investment
decisions.
Chart 2
UK MANUFACTURERS CONCERNED ABOUT BUSINESS
ENVIRONMENT
% citing business environment as bad or
challenging
Source: EEF Shape of British
Industry Survey
21. However, these positive improvements to the
tax system have been more than offset by the government's other
reforms and proposals. For example, the cut in corporation tax
rates was financed by lowering the level of capital allowances
(from 20% to 18%) and by lowering the threshold of the Annual
Investment Allowance (from £100,000 to £25,000). The
result was a tax rise and a significant cashflow loss for growing,
capital intensive companies. EEF is also concerned that future
cuts to the headline rate of corporation tax will be financed
by higher and inefficient environmental taxes placed on manufacturers.
The government's reforms of the Carbon Reduction Commitment and
Controlled Foreign Companies tax rules were not in keeping with
the spirit of its the "New Approach to tax policy making".
And by focusing too narrowly on individual aspects of corporate
tax reform, the government may miss opportunities to think strategically
on how tax reforms can stimulate growth and investment. Each of
these issues is discussed in detail below.
22. Consequently, EEF are concerned that the
government's current approach to tax reform risks leaving business
facing a patchwork of reforms in which the whole is significantly
less than the sum of the parts.
TAXING GROWTH?
23. A modern, competitive and predictable tax
system would not only recognise the significant costs of investing
in modern machinery. It would enable small businesses to invest
in growth. It would attract mobile multinational investment to
the UK. And it would provide the predictability needed to minimise
the tax risks to returns on those investments.
24. However, EEF believe that the government's
tax reform agenda is in danger of falling short of the government's
own priorities, and most importantly, what the private sector
need from the tax system to invest in growth.
Predictability
25. While the "New Approach" represents
a much needed change in how tax policy is developed, the government
has got off to a rocky start in implementing it. For example,
the Spending Review included an unexpected and costly reform to
the Carbon Reduction Commitment. The £1bn reform of environmental
taxation removed tax incentives for companies to reduce carbon
emissions, even though thousands of companies had made significant
investments in complying with the scheme. Far from the government's
commitment to consult on changes in advance, the £1bn tax
change came as a surprise in the fine print of the Spending Review
announcements.
26. Recent announcements on changes to Controlled
Foreign Company tax rules have also increased uncertainty that
the "New Approach" was designed to tackle. In November,
the government published wide-ranging road map for reforming the
corporate tax system. The initial reaction from manufacturers
was positive. But their confidence in the government's ability
to deliver on the important and otherwise well received proposals
was dented by aggressive new anti-avoidance legislation announced
on the 6th of December - days after the road map was
launched - via a written Ministerial Statement from David Gauke,
Exchequer Secretary to the Treasury. One of the measures that
was introduced in the statement with immediate effect, effectively
blocked what the road map indicated government would allow from
2012.
27. These departures from the "New Approach"
have fostered uncertainty and left manufacturers questioning its
patchy implementation: there is little clarity on which tax reforms
would use the "New Approach" and which reforms would
not. The resulting loss in predictability adds unnecessary uncertainty
to firms making long-term business decisions.
Competitiveness
28. Given that their growth is driven by investment
and innovation, the UK's headline corporate tax rate is unlikely
to be the only consideration for firms debating whether to make
long-term investments in the UK or abroad. Changes to environmental
taxes, capital gains taxes, pensions relief, personal allowances
and the top rate of income tax, are also crucial to determining
whether the serial entrepreneurs and multinationals that could
invest in growth and jobs choose to invest in the UK. Apart from
changes to capital gains taxes in the June Budget, businesses
have heard very little on how the government plans to address
the cumulative drag on growth from the breadth of business taxation.
29. Instead, government has put reforms in silos,
focusing narrowly on individual aspects of corporation tax rather
than looking holistically at business taxation and how tax reform
should be support growth.
30. Taxation and innovation provides one such
example. Rather than look in the round at the best way to support
innovation and growth, the government's proposals for the Patent
Box (a 10% rate on profits earned from patented products) and
R&D tax credit unnecessarily split into two the singular process
of innovation. The R&D tax credit offsets costs at the front-end
of innovation, where market failures limit firms' ability to finance
the expensive and relatively risky development of new technologies,
processes and services. The patent-box, by contrast, provides
a very narrow tax break to patent-reliant sectors (such as biotech
and pharma companies) at the back-end of innovation after the
profit has been made.
31. The economic and policy rationale for such
the patent box as currently defined is weak. Patents are only
a small proportion of intellectual property, which is only a small
proportion of innovation. By narrowly focusing on patents, the
proposal erodes the tax base in favour of patent-reliant sectors,
to the detriment of sectors that, for commercial reasons, choose
not to use patents to protect their intellectual property. Nor
is the proposal likely to resolve the thorny issue of firms shifting
their IP to low tax countries. As Table 1 shows, the proposed
UK scheme is not internationally competitive - other countries
either offer a lower rate of tax, or include income from R&D
activity as well.
32. By treating each separately, the UK could
potentially be left with a narrow, inefficient and uncompetitive
patent box and limited reforms to the R&D tax credit. The
preferred option would have been to use the £2bn in combined
costs of the two to design reforms that would provide significant
incentives to the breadth of business to invest in innovation
in the UK.
Table 1
IP TAX INCENTIVES IN THE EU
| County | ETR
| Qualifying IP | Cap
| Can work be performed abroad? | Objectives policymakers
|
| Netherlands | 0%-5% | Patented IP or IP for which an R&D declaration is obtained (R&D IP)
| No | Yes for patent IP. For R&D IP stricter condns
| Attract more R&D activities |
| Luxembourg | 0%-5.72% | Software, subject to copyright, patents trademarks, domain names, designs and models
| No | Yes | Attract IP ownership
|
| Belgium | 0%-6.8% | Patents and extended patent certificates
| No | Yes, if qualifying R&D centre
| Retain and attract R&D + stimulate Belgian patents
|
| Hungary | 0%-9.5% | All IPR (guidelines)
| No | Yes | EU R&D policy/strategy
|
| Ireland | 0%-12.5% | Patent=0%. Other defined IP for amortization
| € 5 Mio for 0% | Yes, relevant for R&D tax credit
| Retain and attract R&D |
| ?? UK somewhere in here ??
|
| France | 15.92% | Patents and extended patent certificates
| No | Yes | Retain and attract R&D
|
Source: IBM
33. The government's narrow focus on the headline rate also
ignores other aspects of the UK tax system which are particularly
distorting and leaves the UK in the damaging position of taxing
growth. Two such areas are capital allowances and environmental
taxation.
— Capital
allowances - The UK's regime is inefficient and internationally
uncompetitive. In
the June Budget, the Chancellor reduced the rate on capital allowances
from 20% to 18% and lowered the threshold on the Annual Investment
Allowance from £100,000 to £25,000, effective April
2012.
— However,
the cost of capital investment is rising and investment cycles
are shortening as new technologies render existing equipment obsolete.
The faster the rate of this depreciation, the earlier manufacturers
are forced to reinvest in new, more productive equipment. A report
by Statistics Canada estimated that, from 1995-2001, the average
depreciation rate for machinery and equipment, based on the declining
balance method, was 27%.
— In
the intervening decade, modern machinery has become more productive
by increasingly incorporating the latest technologies and software.
Empirical and anecdotal evidence suggests that manufacturers are
replacing their machinery and equipment, on average, every seven
to eight years. Yet the UK's current rate of 20% means that manufacturers
are only able to recoup their costs after 30 years, adding a premium
to investing in the UK.
— The
new 18% rate from 2012 will widen the gap between the UK and our
closest competitors and dampen down the capital investment and
growth our economy needs.
Table 2
AVERAGE RATE OF ECONOMIC DEPRECATION
| 1971-1990(1)
| 1985-2001(2) | 1995-2001(2)
| UK tax regime(3) |
| Industrial Sector | 12.3 |
- | - | - |
| Machinery and equipment | -
| 23.0 | 26.8 | 18.0
|
| Manufacturing buildings | -
| 8.7 | 9.9 | 0.0
|
Source: (1) Institute of Fiscal Studies, (2) Statistics
Canada and (3) HM Treasury - figure for 2012
Table 3
AVERAGE SERVICE LIFE OF MACHINERY AND EQUIPMENT, YEARS
| 1985-1989(1)
| 1995-2001(1) | 2005-2011(2)
|
| Machinery and equipment | 12.3
| 9.8 | 7.3-7.8 |
| Manufacturing buildings | 35.6
| 27.9 | 20.2-21.8 |
Source: (1) Statistics Canada and (2) Statistics Canada
& EEF
Table 4
INTERNATIONAL TREATMENT OF USEFUL ECONOMIC LIVES IN 2011
| Country | Recovery period
|
| US | 2011: Immediate
2012: 7 years
|
| Ireland | 5-10 years |
| Germany | 10-16 years |
| France | Plant, machinery, equipment & tools: 10-20 years
|
| Canada | 20 years |
| UK | 2011: 30 years
2012: 33 years
|
| Singapore | 30 years |
Source: US Congressional Research Service, PWC
& EEF
— The
UK's proposed triple taxation of carbon inefficiently saddles
manufacturers with additional costs not faced by other UK sectors
or competitors abroad. The Carbon Price Floor (CPF) Consultation
sets out how government intends to encourage investment in low-carbon
electricity generation by providing a clear, long-term price for
carbon, by taxing input fuels for electricity generation.
— The
government's concern is that the EU-wide carbon price set by the
EU Emissions Trading Scheme may not provide sufficient certainty
over returns to encourage the required level of investment in
low-carbon technologies. The CPF would thus be an additional,
UK-specific tax paid by power generators on their use of fossil
fuels. The current proposals will undoubtedly increase costs to
all electricity consumers, as generating companies pass on costs
arising from this new tax.
— This
carbon price would sit alongside the Climate Change Levy, which
taxes businesses' energy consumption and the £1bn Carbon
Reduction Commitment. This triple taxation of carbon inefficiently
imposes costs on energy-intensive sectors, including manufacturing.
— EEF's
previous support for a carbon price floor was conditional on countervailing
measures ensuring that the overall cost burden on manufacturers
did not increase. For example, imposing a carbon tax on electricity
generation would imply that the Climate Change Levy on electricity
consumption is inefficient. In order to decarbonise the energy
supply, the government should tax carbon either during generation
or consumption, but not both.
— Consequently
the government should substantially lower the CCL on electricity
from the current £4.85 per MWh rate to the EU-mandated minimum
of £0.42 per MWh and scrap the Carbon Reduction Commitment,
which represents a third layer of carbon taxation for 5,000 businesses.
CONCLUSION
34. The UK's business tax regime will, in part,
determine the pace and sustainability of growth and the long-term
competitiveness of the economy. Despite making tax reform central
to its plans for deficit reduction and growth, the government's
current approach is unlikely to address the cumulative burden
that business taxes place on growing businesses. Moreover, the
government's plans for reform fall short of its own principles
of tax reform it set in November 2010, as Table 6 shows.
Table 6
| Government principle
| Government action | Result
|
| Lower tax rates while maintaining the tax base
| The 4p cut in the headline rate provides a strong boost to competitiveness. But the patent box - as currently defined - provides an unnecessary distortion in the tax base without a corresponding benefit to the UK's competitiveness. The government has not yet signalled its intentions on the 50p rate.
| x |
| Maintaining stability | The government's "New approach to tax policy making" provides a strong foundation for introducing predictability in the tax regime. However, the government's reforms to the CRC and the Controlled Foreign Companies rules are not in keeping with the "New Approach". The resulting instability in taxes has eroded government's credibility with business.
| x |
| Being aligned with modern business practices
| By lowering the level of capital allowances, the UK's regime will become increasingly antiquated. Manufacturers replace their machines, on average, every seven to eight years. The tax system will only reflect that cost after 30 years.
| x |
| Avoiding complexity | Although the Office of Tax Simplification will have an important role to play in simplifying the tax regime, the government has given it an overly narrow objective. The OTS should be free to analyse the structural reforms that would deliver significant simplification for UK businesses.
The government has also struggled to avoid introducing complexity in to the tax regime. For example, days after announcing its road map for corporate tax reform, the government implemented legislation that effectively blocked commercial activity that the road map proposes to allow in 2012.
| ? |
| Maintaining a level playing field for taxpayers
| Given recent changes to capital allowances and environmental taxes, and relative to other sectors in the UK and to their competitors abroad, UK manufacturers face a playing field increasingly tilted against them.
| x |
January 2011
| 
