We now have a “spending and tax” government – a very different approach than the “tax and spending” governments of the past. British Chancellor Rishi Sunak has tried to answer the question of who is paying and when for £ 407 billion ($ 568 billion) in coronavirus spending. The answer is everyone, but not right now.
The Chancellor acknowledged that he hopes economic growth will improve the position as taxes levied will rise as the economy recovers. However, that alone won’t be enough to pay for the £ 407 billion spent so far on Covid-19.
The Chancellor has abandoned the decade-long plan to lower the overall corporate income tax rate. The tax rate for large companies will increase to 25% from 2023. The original logic was that a low tax rate would encourage investment, investment create jobs, and bring jobs to the real tax drivers – Pay As You Earn (PAYE) income tax and National Insurance Contributions (NICs). The wages are in turn spent and lead to VAT revenue.
Why the focus on large companies? According to HM Revenue & Customs (HMRC), the majority of corporate tax (CT) liabilities come from a relatively small number of companies. In 2018-19, approximately 4,500 companies had liabilities above £ 1 million but that contributed 55%, or £ 30.2 billion, to the total CT liability. In contrast, just over 1 million companies had liabilities less than £ 10,000 and these contributed only 6%, or £ 3.4 billion, of the total CT liability. It makes sense, of course, to focus on the big payers, not the smaller ones.
It is interesting that the definition of “small” business – companies with a profit less than £ 50,000 – is relatively low and companies with a profit over £ 250,000 are taxed at the full 25% tax rate. This squeezes the impact of higher tax rates on corporate structure further than expected by many.
Other benefits for the Ministry of Finance
There is also a nudge effect. Controlled overseas company legislation means that large companies with overseas operations in countries with lower taxes, defined as 75% of the UK tax rate, may find that more of those overseas profits could be subject to UK taxes. Expect UK based companies to take a close look at their holding structures.
What does it mean to give up the low tax rate?
The headline rate doesn’t really matter. Yield is what really matters. This is determined by the granting and withdrawal of relief from this key interest rate. More relief is a tax gift, less relief is stealth taxes. According to the Organization for Economic Co-operation and Development, the UK received only 8% of its tax revenue from corporate income tax of 19% in 2018. With key interest rates of 33% and 30%, Germany and France only received 4.6% and 5.6% of their tax revenues from companies. The headline rate means little – while we know multinational CEOs review it before embarking on large investment projects, it’s primarily a signal to business as to how the government sees the place of business in business.
The increased relief for investments, the 130% super deduction for investments in new equipment from Budget Day, should help to lower the effective interest rate in the short term. For many companies, the challenge is to have sufficient access to finance to finance the investment in the first place.
The ability to carry losses back to previous periods to get tax refunds will lower the effective tax rate and improve cash flow – but both will have little impact on the post-2023 landscape April 2020 and March 31, 2022 and can now be repaid for up to three years, with a total maximum of £ 2 million for any period after April 1, 2020. Companies that can use this should try their accounts and complete tax calculations as early as possible and file a tax refund claim.
In contrast, the small and medium business research and development tax credit is capped at £ 20,000 each year (plus three times the company’s total PAYE and NIC liability). There seem to be some mixed signals here.
As shown above, the Chancellor can take what he gives with him. So don’t be surprised if these reliefs decrease as tax rates rise. However, with so many businesses struggling right now, there is little to be gained by taxing the loss-making activities today.
Time to re-evaluate some projects?
We need to remember that corporate income tax is a tax on returns on investments and investments are usually long term. As a result, companies need to reassess their projects and determine whether the after-tax return after 2023 is still acceptable. If this is not the case, the project must be reconfigured, canceled or checked. Delaying the surge through 2023 gives corporate management and investors ample time to review their investment plans, understand the likely taxes that will be paid, and consider their response.
The creation of new English free ports located at East Midlands, Felixstowe and Harwich Airports, Humber, the Liverpool Metropolitan Area, Plymouth, Solent, Thames and Teesside, which are special economic zones with different rules to make it easier and cheaper to do business, is quite a departure to the UK. The challenge will be to ensure that existing activities are not simply shifted from outside the freeport to the inside, but that they genuinely attract and promote new investments and jobs. It appears that investment is being encouraged by increasing tax deductions for certain types of expenses within the free ports.
Complexity instead of simplification
Despite efforts by the Tax Simplification Bureau, a lower tax rate for small businesses, a higher tax rate for large businesses, and a lower tax rate for those in between add to the complexity of the tax system. Coupled with the need for many businesses to make payments on account before the final tax liability is known, finance directors may need to wrap their heads in a cold towel to understand what to pay where and when.
Is there more to come?
The bad news is that this is not the end. On March 23rd, the Chancellor is holding a “Tax Day”, on which he will present his plans for the tax system for the next few years. We can be fairly certain that there will be more proposals for possible reform of the UK tax system buried there. Business leaders should take a long-term perspective – not just falling for today’s budget headlines, but waiting to see what comes out of the tax day – that give the real impression of how businesses should be taxed going forward.
The economist Samuel Brittan said: “Only individuals pay taxes, corporations are just a good place to collect them.” Every corporate tax hike actually affects customers, employees and investors. Because of this, the tax cut reversal had to be carefully calibrated. On the surface, it is good policy to tax those without voting rights – corporations have no voting rights – only lobbying power. The effects of this tax will be more noticeable across the economy and that is why the Chancellor has decided today to proceed cautiously.
Realism and honesty
The increase in personal allowances and the subsequent freeze on allowances, postponing a tax hike for large companies until 2023, but enabling increased loss carryforwards and super deductions for investing in innovation, suggests that the Chancellor realizes that it makes little sense today Taxing a troubled economy.
However, if the economy can grow rapidly in the next year or so, there will be more income and more profits to be taxed in later years. The political verdict is that the effects of the increases in the run-up to the next parliamentary elections will not be too strong.
The word “honesty” has been used repeatedly. This may be because the Chancellor, by not increasing key tax rates on VAT, income tax, and social security, but finding other ways to raise funds that are often delayed into the future – the classic way of increasing stealth taxes – is making allegations wants to avoid being stealthy too.
This was a budget designed to postpone the pain but also lay the foundation for future tax hike activities. Businesses have always been a logical goal and they will adapt – but management will have to keep a new eye on new developments and proposals by 2023 as it seems that this was just the beginning.
This column does not necessarily reflect the opinion of the Bureau of National Affairs, Inc. or its owners.
Laurence Field is a Corporate Tax partner at Crowe in London.
The author can be contacted at the following address: firstname.lastname@example.org