House of Lords - The Finance Bill 2011 - Economic Affairs Committee

The Finance Bill 2011 - Economic Affairs Committee Contents

CHAPTER 4: Corporate Tax REFORM

Context

199. In the Budget of June 2010, the Government announced a package of reforms to corporation tax: a reduction in the main rate from 28% to 24% over the four year period from April 2011; a reduction in the small profits rate from 21% to 20% with effect from April 2011; a move to a more territorial basis for taxing the profits of foreign branches; a commitment to reform the rules for controlled foreign companies (CFCs); consultation with business to review the taxation of intellectual property (IP) and the support research and development (R&D) tax credits provide for innovation; from April 2012 a reduction in the rates of capital allowances for plant and machinery from 20% to 18% on the general pool and from 10% to 8% on the special pool and a reduction in the annual investment allowance from £100,000 to £25,000.

200. The commitment to consult was followed up in a document[188] published in November 2010. The introduction to this document said that "the Government will work with business to enhance UK tax competitiveness. It is designed to provide business with certainty over the Government's plans and support the recovery by giving business the confidence needed to invest in the UK. By collecting a series of reforms into a single programme, it will allow Government and business to examine the interactions between different elements in a coherent and systematic manner."

201. Part I of this document set out "The Corporate Tax Road Map" which included the principles for corporate tax reform: lowering rates while maintaining the tax base; maintaining stability; being aligned with modern business practice; avoiding complexity; and maintaining a level playing field for taxpayers. Part II of the document went on to describe the proposals for reform of the rules for CFCs and IP and invited views. Part III detailed interim improvements to the CFC regime and the reforms to foreign branch taxation, both to be legislated in the current Finance Bill.

202. Budget 2011 firmed up these proposals and announced:

· that the main CT rate was to be reduced to 26% from April 2011 and thereafter by 1% each year down to 23% by 2014;

· that businesses incurring expenditure on plant and machinery which they expect to sell or scrap within an 8 year period would be able to make a short life asset election so that the capital allowances claimable would match the true economic depreciation;

· enhanced capital allowances for energy saving technologies;

· reform of the Enterprise Investment Scheme (EIS) and Venture Capital Trusts including raising the rate of EIS income tax relief to 30% from April 2011;

· an increase in the rate of the additional deduction for expenditure on R&D for small and medium-sized companies (SMEs) from 75% to 100% from April 2011, giving a total deduction of 200%;

· confirmation that legislation would be introduced in Finance Bill 2011 to deliver a package of interim improvements to the CFC rules ahead of full reform in 2012 which would allow groups based in the UK to compete more effectively with those based overseas, while protecting against the artificial diversion of UK profits;

· that in May 2011 further consultation would be published on the introduction of a patent box[189] and on R&D tax credits[190]; and

· confirmation that legislation would be introduced in Finance Bill 2011 to provide an opt-in exemption from corporation tax on the profits of foreign branches of UK companies.

CT Road Map and the Move Towards Territoriality

203. Most of our private sector witnesses thought that the CT road map was a welcome move forward. CIOT's comment was typical "We are encouraged at the development of the framework for corporation tax. The UK is very much in need of a long-term route map for its corporate tax system. The government is rightly aiming to make the UK's corporate tax system as internationally competitive as possible—but it needs to bear in mind that the most important aspects of the system are that it is stable, consistent and delivers certainty."[191]

204. Even the EEF, which had some concerns about the content of the CT reform package, were positive about the general approach "The government's commitment to reforming the corporate tax system, therefore, has been commendable in that it has sought to provide stability and to reduce the tax burden on business."[192]

205. Territoriality involves taxing only those profits that arise from activities carried on in the UK, or under the CFC rules, those profits artificially diverted from the UK. Most of our private sector witnesses welcomed the moves in this direction. For example, the IoD wrote "The programme of reform of the taxation of multinationals, including changes to the regime for controlled foreign companies and the move towards a more territorial system, strikes us as going well."[193]

206. The one dissenting view was from Mr Murphy, who wrote "The tax base is being cut because a) the UK will now only tax UK source profits and will exclude from UK tax charge the worldwide profits of companies resident in this country."[194] Mr Murphy added in oral evidence "So however this policy is constructed, it appears to completely miss the point. I cannot see it is going to bring profits here but I do believe it will reduce our tax base, which this policy says it will not but I am quite sure it will. I do not see how you can cut out the world and say our tax base will be as big."[195]

207. Mr Menzies-Conacher disagreed "I think we would disagree with Richard on his general conclusions as well. As far as I can see from the figures, the proportion of corporate tax in the total tax take remains pretty much the same going forward, around 8% of the total, and that seems to have been done via the traditional means of base broadening as the rate has come down. So I do not think there is any particular reduction in the benefit or the cost to the Exchequer in that."[196] There followed a detailed exchange between Mr Murphy and his fellow witnesses, but no meeting of minds.

208. We asked officials about a specific aspect of moving towards territoriality—interest deductibility—and why in 2009 they had justified not moving closer to a territorial system because it would involve restricting the deductibility of interest. Mr Troup said "I do not think there has been a change of heart … A full territorial system, which is not what we are adopting, would require some sort of allocation of interest ...That would have been damaging on business, as was accepted by the Government … Getting the policy right here is a balance between raising the revenue, making sure that the tax system is competitive for the UK and ensuring that there is no opportunity for diversion of genuinely UK profits overseas, which is what the CFC rules are about."[197]

209. The publication of the Government's strategic direction for reforms to the corporate tax regime is welcome. It should promote the stability, consistency and certainty which many of our witnesses saw as so important.

The Main Elements of the CT Reform Package

THE BALANCE BETWEEN THE ELEMENTS OF THE PACKAGE

210. Here again there was a very interesting divergence of views, especially over the balance between cutting the CT rate and reducing the capital allowances on expenditure on plant and machinery.

211. Mr Baron said "We have done some member surveys that certainly indicate that that was something they would like to see, that is favouring getting rid of special reliefs, getting the rate down, and very much favouring the reductions in the corporation tax rate that have been announced in recent budgets."[198] Asked whether their small and medium-sized members shared the enthusiasm for this type of settlement, Mr Baron responded "so far as we can tell from our survey evidence, yes."[199]

212. The Hundred Group was very supportive of the Government's overall approach but accepted that "it is important when costing tax policy proposals … that the impact on all business sectors is properly understood … consultation should begin as early as possible in the policy development process, to prevent inadvertent imbalances being introduced."[200]

213. Others were worried about imbalances. The ATT commented "It is not just the rate of corporate tax which influences the attractiveness of a jurisdiction as a place to base a business. Reliefs available in respect of capital expenditure must also be taken into account. The proposed reduction in the rate of [capital] allowances … will have the opposite effect to the reduction in the rate of tax … [it] is not helpful to the smaller company."[201] Mr Whiting pointed out that "Of course, for many businesses that are not incorporated they were seeing lower capital allowances but no benefit."[202]

214. It was the EEF, representing the manufacturers, who seemed most concerned with this aspect of the CT reform package. They thought that "the benefits of a reduction in the headline rate of corporation tax have been more than offset by the reduction in capital and investment allowances and a rise in other business taxes, in particular for SME manufacturers."[203] They wrote "The government's current approach to corporate tax reform will deliver an internationally competitive headline rate of corporation tax. But as reform stands, it is unlikely to generate the balanced economy the government desires or the broader business tax competitiveness it seeks."[204]

215. Underlining this view in his oral evidence, Mr Kakkad said "The cut in the headline rate only benefits approximately 50,000 companies that pay the high rate of corporation tax whereas capital allowances are paid by every business, not just anybody paying corporation tax. So the reduction in capital allowances ... will raise the effective tax rate."[205] Mr Patel (FSB) made the point that "the accelerated reduction in corporation tax of the top rate is welcomed and it affects lots of our members, but a lot of our members play in the smaller rates field and we would like to have seen an accelerated scheme for that as well."[206]

216. Mr Wales, speaking generally and not specifically in the context of capital allowances, said that "the issue is not always what the nominal rate of tax is; it is what the effective rate of tax is. It is true that there are a surprising number of large businesses still whose investment intentions are somewhat driven by the nominal rate of tax, but really you should focus on what the effective rate is."[207]

217. We asked officials about the balance of the CT reform package. Mr Troup told us "Most unincorporated business are quite small. Small businesses can benefit from an investment allowance of £25,000, which gives them a full 100% write-off for all capital expenditure … on the central point about the manufacturing sector … it is very difficult to do sector analysis, although it is one of those things that we have come back to and looked at with hindsight, but it is very difficult to do forecasting. We have a certain amount of data on the manufacturing sector. The figures we have are that by 2014, we expect the tax liabilities of the manufacturing sector … to fall by around £700 million … So this is not a set of changes that is in some way disadvantaging manufacturing."[208]

REFORM OF THE CFC RULES

218. These comprise interim reforms included in this year's Finance Bill and ongoing consultation on a full reform package for next year. We confined ourselves principally to testing whether the consultation was heading in a satisfactory direction and whether the proposals would be likely to strike an appropriate balance between protecting the Exchequer and producing a regime which would be internationally competitive.

219. Mr Woolhouse commented on the interim reforms "Very broadly, we welcome the interim changes. Together these are steps in the right direction in terms of getting a more coherent regime for taxing foreign profits, so the overall direction is positive."[209]

220. The CIOT saw the main CFC reforms as very significant. The Hundred Group agreed "taken together, these proposed exemptions evidence the Government's commitment to target the CFC rules only at the artificial diversion of UK profits, and provide a welcome indication of the direction of travel towards full reform."[210]

221. The ICAS were very supportive "HM Treasury officials are to be commended for the quality of their engagement with businesses."[211] The CBI was supportive with a caveat "The proposals in this area contain some very useful pragmatic ideas, and the overall direction of travel is clearly positive. However, some of the proposals reflect excessive concern over avoidance and artificial diversion."[212]

222. The partial exemption for finance companies was a bone of contention amongst our witnesses. The proposals, which depend on the nature of the funding for the finance company, broadly taxes its profits at a maximum effective rate of one-quarter of the main rate (5.75% when the main rate has fallen to 23%). The LSEW "generally welcomed [this] as a relatively pragmatic way in which the conflicting aims would be met."[213] The CBI agreed.

223. However, Mr Murphy was much more concerned "if these group treasury operations are located in a tax haven with a 0% tax rate then the UK will treat them as being CFCs but will only subject them to a special low rate of tax of 5.75% by 2014 … As a consequence the tax rates on the profits in the treasury function of this group ... will reduce by 75%. It will be easy to manipulate this to ensure UK source operating profits move for tax purposes into such treasury companies."[214]

224. We asked officials about the cost of the full CFC reforms which will build up to an estimated £840 million by 2015/16. Mr Troup thought "The finance company exemption is likely to be the major element of the costing … the CFC breakdown in the costings document has quite a lot of information about where it comes from."[215] Asked to justify such a large cost for this exemption Mr Troup said "The rate settled … is a classic example of the balance. What was the right level to pitch the CFC charge which would ensure that UK companies would not have a disproportionate incentive to divert profits overseas, while at the same time ensuring that we did collect a reasonable level of tax from UK-based businesses? International comparisons were very important here … The Dutch have a rate of approximately 5%."[216]

REFORM OF IP/INTRODUCTION OF PATENT BOX

225. The CT reform document identifies the Government's approach to the review of IP "Although the Government recognises the value of all types of IP, it is focusing on scientific and high-tech IP because of their particularly strong link to Research and Development (R&D) and technical innovation activities and in order to protect the UK's status as a world leader in patented technologies … The Government intends to introduce a preferential regime for profits arising from patents, known as a Patent Box."[217] "The Government proposes to introduce a 10 per cent rate for profits arising from patents, to apply from 1 April 2013."[218]

226. We asked our private sector witnesses for their early reactions to the proposed patent box. The CBI were positive "Equally supported is the Government's intention to introduce a Patent Box regime from 2013 and its commitment to develop the implementation strategy in partnership with business."[219] The Hundred Group saw it as "a bold first step towards an internationally competitive regime in which to locate high added-value technical activity and the commercial exploitation of valuable IP."[220] Mr Hardwick saw a case for extending its scope beyond patents. Mr Kakkad argued this more strongly, particularly given that since "the Netherlands and others on the Continent do have innovation boxes we are going to be a step behind them from the start."[221] Responding to Mr Kakkad's comments, Mr Baron "was less worried about this. You cannot give tax concessions to everything."[222]

227. Mr Wales had an interesting take "It is difficult to ascertain with any degree of certainty the strength of the Treasury's evidence-base for this proposal … I understand that the Treasury, in putting together the proposal, has not seen any empirical work" by way of post-implementations reviews of the patent box in other countries. "This implies that the evidence used has been entirely theoretical in nature."[223]

228. We asked officials whether they thought the patent box was going to be sufficiently competitive as presently proposed. Mr Troup said "A patent box effectively provides a significant incentive for multinational groups to locate their patent ownership in the UK, to keep the income here and pay a level of tax on it, rather than seeking to transfer either their entire business or their patents overseas, or to find ways in which the patent income is diverted overseas, even though it really 'belongs' here."[224]

FOREIGN BRANCH TAXATION

229. This measure provides an optional, but once effective irrevocable, election for the profits of foreign branches of UK companies to be exempt from UK tax. Where profits would be exempt, losses are not allowable for UK tax purposes. The provisions contain an anti-diversion rule to prevent the exemption from being used to avoid taxation on profits in a UK company. Where an election is made and a branch has accumulated losses over the last 6 years, any subsequent profits are not exempt until the aggregate profits exceed those losses.

230. Mr Wales's reaction was typical of our witnesses "the proposals are a logical extension of recent changes in the way in which the overseas subsidiaries of UK companies are taxed and has been the subject of extensive discussion between officials and taxpayer groups … The changes will provide additional flexibility, particularly for some sectors."[225]

OVERALL

231. Given that:

· the package of reforms may be unbalanced across business sectors, disadvantaging small and medium-sized businesses and manufacturing;

· the scope of the relaxations being introduced is very significant, particularly for controlled foreign companies and for intellectual property; and

· the evidence for the patent box seems largely theoretical;

we consider that post-implementation reviews of the outcomes of this reform package are highly desirable, as they are with all significant tax reforms. We recommend that the timing of these reviews should be agreed with business now and carried out with their involvement, so that the analysis and conclusions are agreed.

Implications for Growth and Tax Competitiveness

232. Finally, we look at the implications of the CT reform package for UK growth and tax competitiveness. The Government's principal objective in developing the CT reform package is to enhance UK tax competitiveness. The introduction to the document states that "The Coalition Agreement sets out the Government's aim to create the most competitive corporate tax regime in the G20 … the Government believes that the corporate tax system can and should be an asset for the UK, improving the business environment and helping to attract multinational businesses and investment to the UK to support the recovery."[226]

233. We discussed with some of our witnesses how the UK compared with our main competitors on international tax competitiveness. Mr Gammie commented in the context of CT rates "I suspect that when we are down to 23%, we will be significantly towards the lower end for economies of our size. Obviously there are many other jurisdictions out there which will have lower rates, but they will be very much smaller economies."[227] Mr Menzies-Conacher's view was that "The headline rate reduction we do see as being a positive and I think it is a positive in the sense that, if you look at the international comparisons, we are looking to attract in people who look at the headline rate and, therefore, that is very significant."[228]

234. We asked our private sector witnesses to what extent the CT reform package, and other proposed changes, would enhance the UK's tax competitiveness. ATT saw "a number of other incentives which are included within the Finance Bill which will encourage businesses to come to or remain in the UK. These include the [changes] to the entrepreneurs' relief rules and the improvements with regard to both the Enterprise Investment Relief and Venture Capital Trusts."[229] They thought the planned reduction in the main rate of corporation tax as improving "the competitiveness of the UK for the siting of major business."[230]

235. The ICAEW supported the Government's drive to increase R&D spending, "but nevertheless we believe that further work is needed to examine whether R&D tax relief meets the needs of smaller companies which undertake innovative activity."[231] The EEF thought that "further corporate and business tax reforms are necessary if tax reform is to support the government's aim of generating long-term balanced growth and significant improvements to business tax competitiveness."[232]

236. In a full paper discussing the link between CT rates and growth, Mr Murphy's view was that there are "weak associations between declining tax rates and increased growth rates and declining tax rates and increased rates of employment, but the relationships do not prove causality … It therefore suggests that no link is proven and that growth prospects will not be enhanced as a result of such cuts."[233] In his oral evidence Mr Murphy concluded "I think that the focus of this policy is seriously mistaken … To get a competitive advantage we are seeing a perverse incentive created and, as a result, we have seen a policy put forward that is going to be significantly costly to the Treasury."[234]

237. Other witnesses disagreed. Mr Woolhouse said "the Emergency Budget [in June 2010] essentially gave a very, very slight reduction in the business tax burden when you combined rates and allowances. That has been accelerated in the last Budget so that is very welcome."[235]

238. Mr Wales commented on the link between CT rates and growth "As regards the reduction of the rate of corporation tax by an additional 1%, the expectation is that it will provide a 'nudge' that will encourage much-needed investment by the corporate sector … It was clear from the Chancellor's first Budget that the programmed series of cuts in corporation tax was not going to be enough to deliver the surge in private sector investment that the UK required, given the course he had set on fiscal policy. I and others have argued since last June for further support for investment."[236]

239. The Hundred Group thought that "Business is unanimous that lower CT rates—both the headline rate and the effective rate—relative to global competition attract a greater proportion of investment … The UK is moving towards a more competitive regime and is fortunate to have HMRC to administer and support business better than most other countries."[237]

240. Mr Jackman expressed concerns about the impact of complexity on growth "The complexity of the material coming out for small business owners cannot be overstated. We did some polling at the start of this year, which suggested that over half of our member businesses were prepared to pay more tax just to see a simplification of the administration around form-filling. You have small and medium-sized businesses there that are willing to pay more so they have more freedom to spend time on growing their business, so they have more certainty in planning ahead."[238]

241. One of our witnesses was very sceptical about any link between corporation tax rates and growth. Some thought that the benefit from reduced rates was likely to be outweighed by the reduction in capital and investment allowances and other changes. Others were positive about the likely effect on growth.

242. The difference between those witnesses who were positive and those who saw the impact of the CT reform package as marginal or negative may have been influenced by the sectors they had in mind when making their assessment. Overall, and particularly for large business, we consider that the reform package makes the UK CT regime more competitive. The effect on small business and manufacturing should, however, be assessed carefully by way of the post-implementation reviews we have already recommended.

188 Corporate Tax Reform: delivering a more competitive system, HMT and HMRC, November 2010 Back

189 Consultation on the Patent Box, HMT and HMRC, June 2011 Back

190 Research and Development tax credits: response and further consultation, HMT, June 2011 Back

191 FBSC 3 paragraph 13 Back

192 FBSC 8 paragraph 3 Back

193 FBSC 7 paragraph 8 Back

194 FBSC 5 Summary paragraph 5 (second) Back

195 Q 111 Back

196 Q 113 Back

197 Q 289 Back

198 Q 138 Back

199 Q 139 Back