I now turn to taxation. First, taxes on business.
The fundamental reform of the corporation tax system which I introduced in 1984 came fully into effect last April. The new system has undoubtedly improved the quality of business investment decisions in Britain, and is also encouraging more overseas companies to set up here.
During the transition to the new system, companies were given advance notice of the main rate of corporation tax for the year ahead. This helped them in their forward planning, and I intend as far as possible to continue the practice of setting the rate in advance.
Accordingly, I can announce now that the main rate of corporation tax in 1987–88 will be unchanged at 35 per cent.—lower than in any other major industrial nation, though the United States is now set to emulate us.
The low rate of corporation tax enables me to introduce a further simplification into the system.
At present, while companies' capital gains are liable to corporation tax, the amount of such gains is first adjusted by a certain fraction so that the effective rate of tax is the same as that on capital gains made by individuals. This dates back to the time when the two rates of tax were far apart.
This is no longer the case. Indeed, the corporation tax rate for small companies is now below the capital gains tax rate. I therefore propose that, from today, companies' capital gains be charged at the appropriate corporation tax rate, without adjustment, save for the indexation which applies to all post-1982 gains.
Hitherto, companies have not been allowed to set payments of advance corporation tax against their liability to tax on capital gains. This means that, where companies distribute capital gains as dividends, the gains are, in effect, taxed twice—once in the hands of the company, and once in the hands of the shareholder. I propose that, under the new system, companies should be able to set ACT payments against tax on capital gains.
Taken together, these changes should yield £60 million in 1988–89.
I also have some further simplification and rationalisation of the corporation tax system to announce.
At present, some companies established before 1965 do not have to pay their corporation tax until up to 21 months after the end of the period for which it is due, whereas companies established since 1965 have to pay their tax after nine months—and indeed some building societies have to pay sooner still. This difference in treatment cannot be justified. Moreover, it is open to an abuse which could put the timing of a substantial proportion of the total corporation tax yield at risk.
I therefore propose that all companies and building societies should be treated the same way, with all liable to pay tax nine months after the accounting period for which it is due.
While business and industry as a whole are doing well, the North sea oil sector has inevitably been hard hit by last year's oil price collapse. My right hon. Friend the Secretary of State for Energy and I have followed closely the effects on North sea producers and their suppliers. The industry itself is generally confident about the longer-term prospects; while, as for the tax system, not only is it inherently price-sensitive, but the companies themselves have repeatedly stressed their desire for stability.
However, in the light of the immediate problems, I introduced legislation last autumn to bring forward the repayment of over £300 million of advance petroleum revenue tax. This has already helped many of the smaller and medium-sized companies faced with cash flow difficulties.
I now propose two further petroleum revenue tax reliefs. First, as from today, companies may elect to have up to 10 per cent. of the costs of developing certain new fields set against their petroleum revenue tax liabilities in existing fields, until such time as the income of those new fields exceeds the costs incurred. Second, there will be a new relief against PRT for spending on research into United Kingdom oil extraction that is not related to any particular field.
I believe that these carefully targeted changes will give a worthwhile measure of relief to the North sea oil sector.
Last year I put the business expansion scheme on to a permanent footing. However, the present rules still produce too much end-year bunching of BES investments, and hence may crowd out some projects and lead to bad decisions on others. I propose, therefore, to permit someone who invests in the first half of the year to claim part of the relief against his previous year's income. This will make it easier for companies to raise BES finance throughout the year.
I also propose to legislate now to pave the way for a new method of collecting corporation tax, to be known as pay and file. Under this system companies will estimate their tax liabilities themselves, and pay on the normal due date. Where it turns out that the initial payment was too low, the company will pay interest to the Revenue; where the initial payment was too high, the Revenue will pay interest to the company. This new approach, which has already been generally welcomed by the business community, is part of a wider programme of streamlining tax collection, and will not come into force until the early 1990s.
I have to set the 1988–89 car and fuel benefit scales for those with company cars. The car scale charges still fall well short of the true value of the benefit, and, as last year, I propose to increase them by 10 per cent. There will be no change in the fuel scales which, as already announced, will also be used for VAT purposes from 6 April. [Interruption.] Training and retraining are vital to a flexible and competitive economy. At present — training [Interruption.] If right hon. and hon. Members are not interested in training, they show themselves to be a fraud, which we know them to be.
Training and retraining are vital to a flexible and competitive economy. At present, training financed by an employer that is related to the employee's current job is allowable against tax for the employer and imposes no tax burden on the employee. But an employer who is willing to finance the retraining of workers for future employment elsewhere may find that the cost of this is not allowable against tax, and the employee may find that he has received a taxable benefit. I propose to remove both these obstacles. This should help more workers to acquire new skills for new jobs.
The past few years have seen a remarkable and welcome growth in the number of small businesses and the self-employed. The Government have done a great deal to lighten the burdens on this vitally important sector of the economy. But I am well aware that problems remain, not least in the field of VAT.
Accordingly, I asked Customs and Excise to issue a consultative document last autumn canvassing a number of changes. In the light of the responses to that document, I have four proposals to make.
Perhaps the biggest problem faced by the small business man today is the trade customer who is late in paying his bills: so late sometimes that VAT becomes due before the bill has been paid. I can do nothing about late payment; but I can, I hope do something about the VAT problem.
My first and most important proposal, therefore, is that, as from 1 October, businesses whose annual turnover is under £¼ million, which covers more than half of all traders registered for VAT, will be able to choose to account for VAT on the basis of cash paid and received. In other words, they will have no liability to pay VAT until they themselves have received the money from their customers. In addition to easing the cash flow problems caused by late payers, this system will, of course, provide automatic VAT relief on bad debts.
I have to warn the House, however, that I cannot legally introduce this change without first obtaining a derogation from the European Community's sixth VAT directive. I am applying for the necessary derogation today. The House will note that the upper limit of £¼ million is considerably greater than the £100,000 suggested in the consultative document.
Second, I propose to give these businesses the option of accounting for VAT on an annual basis. Instead of making quarterly returns, they would make regular payments on account, and then file a single return at the end of the year. This option, which offers considerable streamlining, will be available next year.
Third, the period within which business must apply to be registered for VAT will be extended from 10 to 30 days.
Fourth, there will be changes to the rules for the special VAT schemes for retailers, and more small and medium-sized businesses will be able to make use of the simpler schemes.
I believe that the changes I have outlined, and in particular the option to move to cash accounting, will be widely welcomed by the small business community. The cost will be £115 million in 1987–88 and £60 million in 1988–89.
In addition, I propose to increase the VAT threshold to £21,300, to keep it at the maximum permitted under existing European Community law.
In the light of the responses to the consultative document, I shall not be going ahead either with the withdrawal of the so-called standard method by which retailers calculate their gross takings for VAT, or with the compulsory deregistration of traders below the VAT threshold.
I have one further measure to help the small business man, unrelated to VAT. I propose to increase the limit for capital gains tax retirement relief by 25 per cent. from £100,000 to £125,000.
In any ongoing programme of tax reduction and reform, where much still remains to be done, an essential element must always be the elimination of unintended or unjustified tax breaks, which cause rates of tax generally to be higher than they need to be. Accordingly, I have five proposals to make today to that end.
The first concerns VAT, and has already been the subject of extensive consultation. The House will be aware that a business that provides a service that is exempt from VAT cannot in turn deduct input tax on its purchases. But where the activities of a business are in part liable to VAT and in part exempt the existing rules are excessively generous as to the amount of input tax that can he deducted; and this generosity is being exploited on a growing scale.
The rules must therefore be changed, and the changes, which I proposed to the House last December, will come into effect on 1 April.
There will be special arrangements to deal with the problem of brewers' tied houses.
I am also taking this opportunity to exclude a significant number of small businesses from the scope of this provision. The yield from this change will be some £300 million in 1987–88 and £400 million in 1988–89.
Second, I propose to change the law so that companies in multinational groups which enjoy dual residence will no longer be able to secure tax relief twice on one and the same interest payment. Genuine trading companies will not be affected. This change, which will take effect on I April, follows the similar action recently taken by the United States. It will yield £125 million in 1988–89.
Third, I propose to end the present excessively generous treatment of tax credit relief for foreign withholding tax paid on interest on bank loans. In future, banks will be able to offset this tax credit only against tax on the profit on the relevant loan, and not more widely. This will bring our rules broadly into line with those in most other countries.
The change will apply from 1 April this year for new loans and from 1 April next year for existing loans. It will yield some £20 million in 1988–89.
Fourth, the tax treatment of Lloyd's syndicates as it applies to the reinsurance to close system is clearly unsatisfactory. I therefore propose to bring it into line with that of provisions for outstanding liabilities made by ordinary insurance companies and, indeed, of comparable provisions made by other financial traders. I have asked the Inland Revenue to consult urgently with Lloyd's about the details of the legislation. The new rules will first apply to premiums payable for the Lloyd's account which closes on 31 December this year.
Fifth, I propose to implement the Keith committee's recommendations that interest should be charged in the limited number of cases where an employer does not apply PAYE properly and a formal assessment has to be made to recover the tax. This change will take effect from April next year, and the yield in 1988–89 is estimated at £45 million.
I have one further proposal to make in the broad field of business and tax.
In my Budget last year I suggested the possibility of introducing a measure of tax relief for profit-related pay.
I pointed then to two considerable advantages that might be expected to flow from arrangements which relate pay to profits. First, the work force would have a more direct personal interest in the profits earned by the firm or unit in which they work; and, second, there would be a greater degree of pay flexibility in the face of changing market conditions. Such flexibility is vital if, as a nation, we are to defeat the scourge of unemployment.
Last July I presented a Green Paper on profit-related pay in conjunction with my right hon. and noble Friend the Secretary of State for Employment and my right hon. Friend the Secretary of State for Trade and Industry. I now propose to introduce a scheme of tax relief broadly along the lines floated in the Green Paper.
My proposals depart from those in the Green Paper in one important respect. I am doubling the proportion of an employee's profit-related pay that will be tax free from a quarter to a half, and I am also increasing the upper limits on the relief. For a married man on average earnings receiving 5 per cent. of his pay in profit-related form, the tax relief will be equivalent to a penny off the basic rate of income tax. The cost will inevitably depend on take-up. It could be £50 million in 1988–89, building up to substantially more than that, as take-up grows. and as the proportion of an employees's pay which is profit-related rises.
Profit-related pay is no panacea. But then there are no panaceas. What it is is a tool to help British business gradually to overcome one of our biggest national handicaps — the nature and behaviour of our labour market. I am today challenging British management to take advantage of that tool and to make good use of it, for the good of their firm, their work force and their country.