Clause 3 — Small companies' rates and fractions for financial year 2007

Orders of the Day – in the House of Commons at 3:35 pm on 30th April 2007.

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Votes in this debate

Question proposed, That the clause stand part of the Bill.

Photo of John Healey John Healey The Financial Secretary to the Treasury

We have so much to look forward to during these two days of deliberations in this Committee of the whole House. You can tell that Labour Members are relishing and looking forward to them, Sir Alan.

Clause 3 was debated on Second Reading. It sets the small companies rate of corporation tax at 20 per cent. for 2007-08 and sets the fraction by which the tax rate for those companies with profits between the small companies rate and the main rate thresholds is calculated at one fortieth. It also sets the small companies rate for profits derived from North sea oil activity at 19 per cent. and the fraction for those companies with profits between the thresholds at 11 four-hundredths. This clause should stand part of the Bill.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

It is appropriate to start our consideration in Committee by discussing the Chancellor's tax raid on small businesses. He followed our lead by doing the right thing for large businesses, but he did the wrong thing for small businesses. Although the cut in the corporation tax headline rate for large companies from 30 to 28 per cent. is welcome and has grabbed the headlines, small companies face a substantial rise in the tax that they pay. The Bill increases the small companies rate from 19 to 20 per cent., although the Chancellors' Budget speech set out a series of further increases, which we shall debate in subsequent Finance Bills, up to 22 per cent. from 1 April 2009.

The increase in taxation fails to acknowledge the contribution that small businesses make to the UK economy. Small businesses, about one quarter of which are small companies, employ 58 per cent. of the private sector work force—about 12 million people—and contribute more than 50 per cent. of UK turnover. While larger companies will benefit from a reduced corporation tax rate, smaller companies will face a tax hike. In an attempt to sweeten the blow to small companies, the Chancellor simultaneously proposed a new set of complex tax reliefs, yet many small businesses will either be ineligible for them or will fail to apply for them.

After 11 Budgets and multiple rate changes, the Chancellor has almost come full circle on the taxation of small companies. When the Government came into office, the small companies tax rate was 23p in the pound. They reduced it to 21p in 1997, and to 20 per cent. in 1998. In 1999, a new 10 per cent. rate was introduced, which was reduced to zero in 2002, only to be put back up to 19 per cent. for non-corporate distributions in 2004. In this year's Budget, the small companies rate was increased from 19 to 20 per cent., with further increases proposed over the course of the next three years. There have been so many changes to the small companies tax rate, yet so little progress: by the time we reach April 2009, the rate will be just 1p lower than it was when the Government came to office in 1997. Given so many changes, one can conclude only that the Chancellor cannot make up his mind about how he regards small businesses: he cannot decide whether to encourage or discourage them; whether to congratulate them on being engines of growth or reprimand them for tax avoidance; or whether to give them reliefs or to reduce their profits.

The Chancellor may not be able to make up his mind about small businesses, but they have certainly done so about him. Following his Budget, the comments in the papers from business organisations demonstrated their thoughts about him, particularly in relation to the small companies rate. Carol Undy, of the Federation of Small Businesses said:

"This is the Chancellor's eleventh Budget and this year's offering is no different to the others—he gives with one hand and takes with the other. Corporation tax was cut for large firms but increased for smaller ones."

The federation went on to say:

"Tax cuts aimed at big business will do nothing to ease the burden for the majority of the private sector."

The British Chambers of Commerce said:

"many of our members feel let down and are dismayed by the measures taken which will hit their competitiveness and increase their tax burden."

The Association of Chartered Certified Accountants declared:

"This is no encouragement for the small business sector".

Chas Roy-Chowdhury, the head of taxation, said it was

"a very surprising Budget from a Chancellor who claims to be a friend of enterprise. It seems to be a case of robbing small business Peter to pay big business Paul."

One of the themes that emerges when one talks to small business organisations is that, despite the complexity of the Budget, many of their members feel that small companies are being penalised to fund the tax cuts experienced by large businesses. Chas Roy-Chowdhury commented:

"This decision flies in the face of the Chancellor's previous aim to encourage more businesses to incorporate".

Many small businesses have commented individually that the Budget was aimed at wooing the City, not at wooing small businesses. Pauline Birdsall, a director of a freight forwarding company in Hayes, Middlesex, summed up the mood of many small businesses by saying:

"What do we have to do to makes ends meet? The Government is clearly afraid of big businesses going abroad, but they don't seem to worry much about the small firms. As a group we are major employers and we are totally undervalued."

A Hampshire business woman, Lynn Willrich, said that small businesses had been forgotten by this Government. She continued:

"We are a very small company and we are being hit from all angles. We feel as though we are paying the price for big companies getting a tax break.... The Government should be helping us not hindering us."

The Chancellor may have presented his tax con as a tax cut, but small businesses saw through his sales patter and saw nothing in it for them. In a survey of 220 owners and managers of small firms conducted by the Forum of Private Business, 82 per cent. of respondents said that the tax hike in the corporation tax rate for smaller companies would be damaging to their company; 65 per cent. felt that, overall, the Budget would have a negative effect on their business; and a third felt that the plans laid out in the Budget made the tax system more complex. Only 4 per cent. regarded the Budget as positive for them—only 4 per cent., compared with 82 per cent. who felt that the Budget would damage their business.

Photo of Michael Fallon Michael Fallon Chair, Treasury Sub-Committee

I thank my hon. Friend for giving way so early in what I think is a rather important speech. Does he agree that many small businesses are not involved in research and development and may not invest on an annual basis that would enable them to qualify for changes in the annual investment allowance? A lot of small businesses are quite happy to be small businesses. Why should they now be discriminated against?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

My hon. Friend makes an important point. The sectoral impact of the tax changes is an issue: different sectors see the changes proposed in the Budget very differently. I shall discuss how some sectors feel in a moment. There is a sense that the way in which the Chancellor has sought to offset the tax increase favours certain types of business rather than others, and that rather than make the business environment better for all businesses, he has made it better only for some.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

I agree with my hon. Friend Mr. Fallon. The Chancellor has admitted that he does not understand mathematics, but the clause shows that he does not understand the basics of business and that not all businesses are the same. He assumes, in a very broad-brush way, that all small businesses can benefit from the provisions when, in fact, only a small proportion do so.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The Chancellor made his own remarks about his maths, so I shall not make any about his sums not adding up. Certainly, he cannot work out the reality of business in Britain today. Some 75 per cent. of production in our economy comes from the service sector, yet the tax changes that he has proposed primarily help asset-rich businesses that invest in fixed capital, rather than the businesses that are so typical of the service sector, which invest in human capital as well. That is an important difference to highlight.

Photo of Julia Goldsworthy Julia Goldsworthy Shadow Chief Secretary To the Treasury, Treasury

Does the hon. Gentleman agree that, in addition to different sectors being affected in different ways, there will be significant regional differences in the impact of the changes? Areas such as my constituency, where the major employers are very small businesses that are almost on a micro level, will be hit disproportionately, and will suffer more than areas that have many large employers.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 3:45 pm, 30th April 2007

The hon. Lady makes a valid point, and I suspect that she will find in her constituency, which has a high proportion of tourist-related businesses, that those businesses that do not invest in fixed assets will suffer, because they will not benefit from the offsetting tax changes that the Chancellor has made. There is a double whammy for businesses in her constituency, as there is for so many businesses across the country.

It is not surprising that a large number of businesses across the country criticised the Budget for the impact that it would have on them, but what did the Treasury say in its defence? The Economic Secretary to the Treasury, speaking at the British Chambers of Commerce's annual conference, said that the Chancellor had raised the small companies tax rate to clamp down on

"individuals incorporating to avoid paying their due share of tax. Without addressing this, this trend would have continued at a cost to the rest of the taxpaying population of billions of pounds—money which could not be afforded."

At least he did not say that the Confederation of British Industry told the Government to say that.

The Financial Secretary to the Treasury has said that

"the lower rates of tax have resulted in a significant number of people incorporating to take advantage of them, not to invest in business, but simply to extract the company profits in a way that reduces their personal tax and national insurance liabilities."—[ Hansard, 23 April 2007; Vol. 459, c. 758.]

That has been a recurrent theme in the Treasury's defence of the change in taxation. Treasury Ministers who parade that defence seem to forget that it was they who introduced the zero per cent. rate of corporation tax in the Finance Act 2002. They sought to use the measure to encourage enterprise, and of course it led to increased incorporation. In a way, they are unpicking their own reforms, and rather quickly. Every small company is at risk of losing out as a consequence of the Government repairing the damage that they did.

Photo of John Healey John Healey The Financial Secretary to the Treasury

Does the hon. Gentleman accept that in the 2002 Budget to which he referred, and the 2000 and 1999 Budgets, in which we made changes to the small companies rate, we made it clear that our policy purpose in making those changes was to encourage growth, investment and innovation?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I think that I took part in the scrutiny of the Finance Act 2002, and I heard the Financial Secretary's colleague, the Paymaster General, make the assertions that he has just made. The error that the Government made then was to assume that companies were the only engines of enterprise. They focused on a narrow set of business organisations, forgetting that sole traders and partnerships were contributors to enterprise, too. The changes that they introduced in 2002 were focused on encouraging companies to be entrepreneurial, but they forgot that a large amount of entrepreneurial activity comes from outside the company sector, as the Financial Secretary said himself on Second Reading last week—I will come back to those comments later. Only a quarter of small businesses are incorporated; in a way, that underlines the weakness of the Government's arguments in favour of making the change back in 2002.

Photo of David Gauke David Gauke Conservative, South West Hertfordshire

Was it not widely predicted, even back in 2002, that the zero rate of corporation tax would result in a lot of small businesses incorporating in order to benefit from a better taxation system? The mess that the Government have got themselves into was entirely predictable, even in 2002.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

My hon. Friend is right. According to my hazy recollection of the scrutiny of the 2002 Finance Bill, the Institute for Fiscal Studies produced estimates of the tax cost of the zero per cent. corporation tax rate, and the Government rather dismissed those estimates at the time. The wave of incorporation was predictable, on the basis of what happened in 2002. The Government are now unpicking that move, with the aim of tackling tax-motivated incorporation, but in doing so they are harming every profitable small company, whether it employs one person or 100 people. That is the problem with the change.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I know that the hon. Gentleman is anxious to make his first intervention in Committee—in many respects it is surprising that it has taken 14 minutes for him to try to do so—but he will have to wait a moment longer. Those changes have been unpicked, and they will affect every small company, regardless of size. If they are profitable, they will have to pay more taxation, so the issue arises about the way in which the Government have sought to tackle a problem that, in part, is their own creation.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

I am grateful to the hon. Gentleman for his usual generosity. I, too, served on the Standing Committee that considered the Finance Bill of 2002, and I remember some of those arguments—they are hazy, to use his adjective about his own memory and, indeed, about mine in some respects. However, I do not recall that he and his hon. Friends voted against that zero per cent. rate in the 2002 Standing Committee debates. Does he have a different recollection?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

This is a debate about what is happening in the aftermath of that debate. It is rather rich of the Government to come back five years later, and almost airbrush out the history of those measures, ignoring the fact that they started that process by altering the balance between incorporation and being unincorporated. The problem is that the Government are using a crude sledgehammer to crack a nut, and they are causing a problem for many small businesses.

Let us consider for a moment the issue of incorporation, because it is an argument that has been prayed in aid by the Economic Secretary and the Financial Secretary. If we look at the way in which the number of companies that have incorporated has changed in recent years, we can see that in the year that the zero rate was introduced there was an increase in the number of companies that incorporated. That trend and step change in incorporation has continued, and the year after the zero rate was scrapped the number of companies registered was 372,000, compared with 325,900 in 2002-03. It appears that there has been a general increase in the number of companies that have incorporated, and it is hard to deduce a causal link between the two, given the fact that the large number of incorporations has continued for some time afterwards.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

The hon. Gentleman may not have the figures, but can he possibly disaggregate them, because over the same period a new regime of limited liability partnerships came in, which enabled partnerships to incorporate, and some of them are included in the figure of 372,000 to which he referred? It does not help us greatly with this debate unless he can disaggregate.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The hon. Gentleman is right. I am not sure that those figures include limited liability partnerships, but I certainly do not think that the numbers have increased. I do not think that it is a huge number, and it certainly would not have a distorting effect on the most recent year, as the hon. Gentleman is perhaps suggesting.

Let us look at the arguments that have been used. Simon Sweetman from the Federation of Small Businesses made this response to the change:

"On the face of it, the rise in the small companies rate is very disappointing for our members, because it is addressing a problem that I don't think exists, which is the notion that people incorporate for tax reasons. It was certainly true at one point, but I don't think it happens any more."

The British Chambers of Commerce further argued that the rise in the small companies tax rate

"sends out a negative message to the small business community. Closing a loophole, which was initially created by Government incentives, penalises small businesses unnecessarily."

It went on to say that it does not understand

"why the Government chose to use a blunt instrument impacting on all small businesses rather than focussing their resources on targeting those who are using Managed-Service Companies as a front for tax avoidance".

There is a serious doubt in the small business community, therefore, about whether tax-motivated incorporation still persists as an issue and, if it does, whether raising the small business rate of corporation tax is the way to tackle it, as there may be other ways of doing so.

The Chancellor sold the package to small businesses because of the offsetting tax changes, such as the extension of the 50 per cent. first year capital allowance for this year and the changes in subsequent years, and the changes in the research and development tax credit. It is worth remembering the impact that such change will have on the profitability of businesses and their ability to invest for the future. In its comment on the Budget, the Association of Convenience Stores pointed out that

"convenience stores generally operate on a 1 to 2 per cent. net profit margin, and the increase in the rate of corporation tax on small business will further erode this."

How on earth will they find the profits to survive as a business and create new earnings for the owners and shareholders, and will they be able to retain sufficient profits to enable them to grow and develop in the future?

Many service sector companies will face that problem as a consequence of the change. I am not sure that they will benefit from the more generous capital allowances or the changes to the research and development tax credit. For many service sector companies, investment on such a scale is rare, and the Government should remember the importance of the service sector to the economy as a whole. As I said earlier, about 75 per cent. of the economy is accounted for by the service sector, so if the Government start to attack that sector and restrict its ability to grow and develop, they are creating a long-term problem.

We can all identify service companies in our own constituencies that might not benefit from the change, such as hairdressers or caterers. Let us take a business that I know—a conference business run by a friend of mine. It does not need to invest very much in physical assets, but its retained profits are necessary to provide the capital to expand the business and generate the money that can be used to take risks in growing the business. Service sector businesses will be worse off as a consequence of the Budget. They will suffer the tax rise, but they will not be eligible for the reliefs that the Chancellor increased in the Budget.

One argument for the tax increase is that it will tackle tax-motivated incorporation. The other argument deployed by the Chancellor is that there will be other moves to compensate for that. When we consider clause 3 in the round, we should remember the arguments put by the Chancellor. It is important to remember that the changes to capital allowances are a timing difference. Capital allowances change the phasing of permissible capital expenditure for taxation. Increasing the first year allowances accelerates the tax relief; it does not increase the amount available for tax relief over the lifetime of the asset. It is a timing difference, not a tax cut.

Victor Dauppe, a tax principal at MacIntyre Hudson, was right when he said:

"Extra corporation tax is permanent, and the increased capital allowances are either temporary, not yet in place or unavailable for some companies."

The Financial Secretary to the Treasury agreed with that. In last week's Second Reading debate he said that

"the changes to capital allowances have a largely temporary timing effect".—[ Hansard, 23 April 2007; Vol. 459, c. 758.]

That indicates the deal that is on offer to small companies. They see a permanent increase in their rate of corporation tax which is offset—if they are eligible to make a claim—by a temporary short-term timing difference that improves their cash flow today, but is reversed later.

Photo of Stewart Hosie Stewart Hosie Shadow Spokesperson (Women), Shadow Spokesperson (Home Affairs), Shadow Spokesperson (Treasury)

The hon. Gentleman is right to say that the additional tax take may erode small companies' ability to invest. He is also right to suggest that many of them will not be eligible for some of the existing reliefs. The changes this year and in the following two years will take £1.2 billion in additional revenue, and perhaps £100 million out of Scottish business. What impact does he think that will have on the 98 per cent. of Scottish businesses that employ fewer than 50 people, but which generate 41 per cent. of all revenue in Scotland? What impact does he think £100 million of their profits will have on their ability to invest in the future?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The hon. Gentleman raises an important point which reflects the issue raised earlier by Julia Goldsworthy about the regional and national effects that the changes will have. I should have thought that £100 million coming out of the retained profits of Scottish companies would have a significant impact on their ability to develop, expand and grow. We need to be aware of the effect that the change will have on companies up and down the country. It looks as though Helen Goodman is ready to intervene—but no, she is just looking very eager and anxious.

The thing to remember is that every profitable small company will pay the increase in corporation tax, but not every company will qualify for or apply for R and D tax credits or benefit from the changes. Use of the R and D tax reliefs is as low as 11 per cent. A third of companies for which the tax credits were relevant did not claim them, because according to a survey produced by PricewaterhouseCoopers in 2006 the process was perceived as too difficult. The argument that the tax increase is fine because it is offset by reliefs and allowances elsewhere does not hold true if a business feels that the process of claiming the reliefs and allowances is too complex or that they do not apply to it. The Government cannot pretend that improving the reliefs is the answer to the additional tax that they have imposed on small companies; that argument does not wash because of the low take-up and use of these reliefs.

Photo of Philip Dunne Philip Dunne Conservative, Ludlow 4:00 pm, 30th April 2007

Does my hon. Friend agree that small companies may be affected not only by the reliefs that he has just talked about but by the empty property relief—a substantial relief that is not even part of the Finance Bill but which is being restricted significantly, raising nearly £1 billion for the Chancellor? That will also have a disproportionate effect on small companies that have empty premises, perhaps through no fault of their own but because of default by a subsequent tenant.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

My hon. Friend makes a valid and important point about the widespread impact of the Budget on small companies, but I will not be tempted down that route as it falls outside the scope of clause 3. I am sure that his point will be heard by those groups that take a close interest in the matter.

I was talking about the use and take-up of reliefs and their growing complexity. To offset the increase in corporation tax, small companies will have carefully to consider how they can claim R and D tax credits or capital allowances and will have to navigate their way through a complex system. A poll of members of the British Chambers of Commerce said that 69 per cent. believed that business taxes should be streamlined so that taxes were lower overall and so that the system of tax allowances and exemptions was abolished. A large proportion of businesses prefer a simpler, lower tax burden to one with higher rates offset by more generous exemptions and allowances. A survey by the Forum of Private Business showed that tax allowances designed to encourage investment in companies did not appeal to smaller businesses.

The general concern about the take-up rate for the changes to the allowances and the effects that they will have led the Treasury Committee to recommend in its report on the Budget that

"prior to the 2009 Budget, the Treasury review the impact of these measures on business investment in order to ensure that the measures are having a positive impact on investment and business growth, including the impact on small businesses that do not qualify for R and D tax credit or the Annual Investment Allowance."

Clearly, there is widespread concern about whether the allowances will be taken up. If they are not, small companies will be hit by the increase in the small companies rate of corporation tax.

It is worth considering the impact on small companies of the increase in the small companies rate of corporate taxation. The Red Book estimates that the cost to small businesses in the 2007-08 tax year will be about £10 million; that in 2008-09 it will be £370 million; and that in 2009-10 it will be £820 million. That is a £1.2 billion tax take from small companies. How will that impact on the individual companies that are subject to the regime?

The Financial Secretary said last week on Second Reading that there were about 4.3 million small businesses in this country, that approximately three quarters of those were self-employed and therefore not affected by the increase in corporation tax in the Budget and that, of those that remained, a further quarter did not pay corporation tax because they had no declarable corporation tax profits. That means that approximately 800,000 businesses will be affected. In the 2009-10 tax year, they will pay £820 million. That implies an average increase in corporation tax to those businesses of £1,000 per business.

Photo of Stephen Timms Stephen Timms The Chief Secretary to the Treasury

The hon. Gentleman refers to the table in the Red Book. Will he confirm that the revenue that he described is being recycled back to small businesses through the capital allowance measures?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

That assumes that small businesses take up the allowances and reliefs that are available. The Chief Secretary was careful in his choice of words, because all small businesses can claim the increase in allowances, regardless of whether they are incorporated. The average benefit from the increase in allowances is approximately £68 per small business. Small companies will pay on average £1,000 more in corporation tax, but the group of 4.3 million will gain only about £60 a year. That is not a fair deal for small companies. The benefit is being spread rather thinly.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

Is not that another example of the Chancellor simply saying, "I'm going to take your taxes and you can claim them back as a business person but only if you do exactly as I say"? It is management by the clunking fist, not the invisible hand of Adam Smith.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

My hon. Friend makes an important point. The Chancellor is loading incentives towards a specific sort of business. If businesses invest in research and development and physical assets, the Government will give them some tax relief and allowances, but if they do not, they will not be able to claim the reliefs. A small company will have to pay more tax anyway. The Chancellor penalises small companies and spreads the benefit among all business.

Photo of Kitty Ussher Kitty Ussher PPS (Rt Hon Margaret Hodge MBE, Minister of State), Department of Trade and Industry

Is not it the Conservative party's policy to encourage small businesses to invest, because that will lead to their greater prosperity, productivity and growth? Does not the hon. Gentleman accept that a company with profits of up to £100,000 that invests half the profits will end up paying 40 per cent. less tax than it would without the Bill?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The hon. Lady makes a mistake. She assumes that investment is about the purchase of physical assets that qualify for capital allowances. However, people can invest in their businesses and get them to grow in different ways by recruiting more members of staff and developing the skills of their work force. Investment is not simply about buying machinery. Investment means that companies can grow in a range of ways, not necessarily through the acquisition of physical assets.

That is the problem with the Government's approach to the Budget. The Chancellor appears to be interested in only a narrow group of companies. He is happy to reward businesses that buy physical assets, but penalises small companies generally through increasing the small companies tax rate. The Budget's failure is penalising businesses that invest in people rather than machinery, equipment and plant. The hon. Lady should consider the small businesses in her constituency, especially those that do not invest in plant and machinery but want to take a risk by employing new members of staff. They will be hit most hard by the Budget—they will pay the higher rate of small companies taxation but will not receive in return the increase in capital allowances, which, when averaged out across all small businesses, amounts to about £60 per company. That is not much of an incentive, even if the hon. Lady's argument held water.

That is why the post-Budget survey undertaken by Populus for the British Chambers of Commerce showed that only 17 per cent. of businesses thought that this year's Budget would improve their competitiveness. That is the reality of the business reaction to the Budget on the ground. The theory that the Chancellor has put forward in the Budget, and which hon. and right hon. Labour Members have put forward, too, does not hold water. Businesses can expand in ways other than investing in fixed capital and assets. Indeed, the Chancellor is penalising those businesses that do not invest in fixed capital and assets, by increasing the small companies rate of taxation.

Photo of Philip Dunne Philip Dunne Conservative, Ludlow

My hon. Friend may not have heard the Economic Secretary to the Treasury, speaking from a sedentary position, identify research and development as a possible alternative means of securing some benefit from the Budget. The Economic Secretary is of course correct in his assessment that that part of the economy can take advantage of the reliefs. However, he is completely incorrect, in that he ignores the service sector, which my hon. Friend has rightly highlighted. The service sector gains no such benefit from the £50,000 limit, from either R and D relief or capital allowances, yet it is a sector that is growing very fast. Many companies in my constituency are engaged in mail order, for instance. They might invest in a new catalogue or brochure for their customer base, but they will not benefit from either of the reliefs. There are many other examples of companies in the service sector that do not invest in R and D, or in plant and machinery for capital allowances.

The Chairman:

Order. I should tell the Committee that I understand the link in the argument between the tax measure that is the subject of clause 3 and the allowances. However, the allowances are referred to more substantially in clauses 36 and 49, which are not due to be taken on the Floor of the House. If the debate extends too far into the question of allowances, it may be that the Chairman will not favour much debate in the Public Bill Committee.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

Thank you for your guidance, Sir Alan. You are absolutely right to draw the Committee's attention to the rather narrow nature of clause 3. I had hoped just to establish the problems inherent in how the offsetting of allowances had been set up, and why they do not justify the increase in the small companies rate of taxation. However, we shall not need to make that point for much longer, as it is a clear deficiency in the Budget, at least to the Opposition.

That brings me to the conclusion of my remarks. By increasing the small companies rate of corporation tax, the Government have sought to address a problem of their own making caused by the introduction of the zero per cent. rate back in 2002. The risks were there at the time. However, the attempt to correct the problems that arose then will mean that all small companies that are profitable will have to pay an increase in corporation tax. In order to tackle the apparent abuse of the Government's own rules by a small group, all small companies will have to pay higher corporation tax.

Ministers may talk about large groups, but it would interesting to hear just how many businesses the Government think are taking advantage of the system. However, arguing that all small companies should be penalised and that the only way to offset the increase in corporation tax is to focus on extending reliefs and allowances, where there is no guarantee that they will be taken up, is the wrong approach to tackling the issue. Small companies are the backbone of the economy. They play an important role and are an engine of growth in the British economy. My concern is that the tax increase in question will damage the competitiveness of that important sector.

Photo of John Healey John Healey The Financial Secretary to the Treasury

I am grateful to the hon. Gentleman for giving way, because I am anxious to put one point to him before he sits down that he has not yet covered. Will he reverse the tax change in clause 3 in future?

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

I am not going to stand here today and write the Budget of my hon. Friend Mr. Osborne for 2010. We will bring forward at the appropriate time our own proposals to stimulate the activity of small businesses and to ensure that they continue to act as the engine of economic growth. We now need to focus on the measures before us today. Small businesses up and down the country have acknowledged that this corporation tax increase will have a significant and damaging impact on them, and that it will lead to some of them being unable to expand and to invest in the future. The Chancellor has sought to extract £1.2 billion from them over three years in corporation tax. That is an attack on those companies and it will do untold damage to them. That is why I oppose the measure before us.

Several hon. Members:

rose —

The Chairman:

Order. I should perhaps mention that, as we are in Committee, the correct form of address to the Chair is not "Mr. Deputy Speaker". It should either be "Mr. Chairman" or "Sir Alan". In the spirit of egalitarianism, I favour neither one over the other.

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland 4:15 pm, 30th April 2007

I am pleased to take part in this debate, even though I did not have the pleasure and privilege of taking part in the debates on these matters in 2002. I wish to support clause 3. In considering the taxation of small and medium-sized enterprises, any Government will try to balance two factors: the health of the small business sector and the fairness of the tax system. No one here today underestimates the importance of SMEs. According to statistics produced by the Small Business Service in August 2006, 99.9 per cent. of the 4.3 million business enterprises in the UK in 2005 were SMEs, accounting for 59 per cent. of business employment and 51 per cent. of turnover. Clearly, the small business sector is a key source of innovation and enterprise, and it is important that the tax system provides incentives and rewards for those qualities. Of the 4.3 million business enterprises, 2.7 million are sole proprietors and 500,000 are partnerships, which means that only 1.1 million are companies that could possibly be affected by this change.

As well as taking account of the health of the small enterprise sector, we need to protect the revenue base. Tax must be equitable, as between individuals in similar circumstances. Businesses should not be distracted from their real purpose by tax-induced decisions or activities. Conservative Members belong to a party that seems, particularly in the light of the recent remarks of Mr. Hoban, to be anti-tax. Tax seems to be an optional extra for them. The most recent example of this involved Lord Laidlaw, who promised the Lords Appointments Commission that he would domicile himself in the UK in order to pay UK taxes—

The Chairman:

Order. The hon. Lady is straying outside the scope of clause 3.

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland

I beg your pardon, Sir Alan. I was simply trying to make the point that it is important for the Government to promote a culture of respect for the tax system, and I feel that Conservative Members do not always show the kind of understanding that they would need to have if they were going to run an effective tax system—

The Chairman:

Order. That sounds more like a Second Reading point to me.

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland

The tax system will work only when the rules are perceived to be fair. People who abuse the small companies rate by moving from unincorporated to incorporated status purely to pay less income tax and avoid paying national insurance contributions are engaging in precisely the kind of tax-induced activity that does not promote a stronger economy or flourishing enterprise. It is completely unfair if some people can lower their tax bill by moving from unincorporated to incorporated status, while Joe Bloggs, who has to pay his tax through PAYE, does not have that opportunity. That is the essential point at issue in this tax change.

The Chancellor of the Exchequer made it clear in his Budget speech in March that he was introducing the change

"to deal with individuals artificially incorporating as small companies to avoid paying their due share of tax."—[ Hansard, 21 March 2007; Vol. 458, c. 815.]

The clause raises the small companies rate from 19 to 20 per cent. this month, with further increases to 21 and 22 per cent.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

A statement by Simon Sweetman of the Federation of Small Businesses contradicts the hon. Lady's point about the clause. He said:

"It is addressing a problem that I don't think exists, which is the notion that people incorporate for tax reasons. It certainly was true at one point, but I really don't think it happens any more."

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland

In a few moments, I shall quote some other independent commentators who said after the Budget that the problem does exist.

The object of the clause is to reduce the differential tax rate between the incorporated and the unincorporated. For the sector as whole, the three allowances are not just intended, but estimated, to be tax-neutral. The introduction of the annual investment allowance for 100 per cent. of expenditure up to £50,000, the 175 per cent. tax credit for R and D and the new tax credit for environmental investment offset the effect of the tax rate increase overall. Without that action, the Exchequer would lose billions of pounds, as more businesses incorporated in an attempt to avoid paying income tax and national insurance.

Photo of Philip Dunne Philip Dunne Conservative, Ludlow

How does the hon. Lady reconcile her statement about offsetting with what I said about the change to empty property relief, as a result of which businesses in this country will contribute nearly £1 billion to the Exchequer?

The Chairman:

Order. I thought that I had taken that out of the equation, as it is not in the Bill.

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland

Thank you, Sir Alan.

A further problem is that the current small companies rate benefits large companies, because it is levied on the size of profits, not on the size of the company. The change will help to focus the tax system more effectively.

To return to the point raised by Mr. Newmark, after the Budget speech Andrew Tenon, a tax director at Tenon, commented:

"There is no doubt that many people have incorporated to save tax".

The Institute of Chartered Accountants said—again, after the Budget—that,

"the Government is concerned that the small companies rate continues to be subject to manipulation...This is probably a reasonable analysis".

The scaremongering from Conservative Members is not justified. I suggest that they turn to chart 3.1 in the Red Book, which compares international corporate tax rates. They will see that current UK rates are below the G7 average, and that the new UK rate will be below that of the EU15. The Government continue, through a range of policies, to encourage business growth by encouraging investment and innovation.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

I am sure that in Bishop Auckland, as in Braintree, the majority of small businesses are in the service sector and are not capital-intensive. Has the hon. Lady therefore spoken to small businesses in her constituency? If so, what percentage of them think that the tax increases will benefit them?

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland

As a matter of fact, there is a large amount of manufacturing in my constituency, and it is important to support this country's manufacturing base.

To conclude, it is vital that, at the same time as encouraging the small business sector, we treat small businesses and self-employed people in an even-handed way.

Photo of Vincent Cable Vincent Cable Shadow Chancellor of the Exchequer, Liberal Democrat Spokesperson (Treasury)

I strongly agree with the approach adopted by Mr. Hoban, and with his conclusions. He set out the arguments pretty comprehensively, and I do not think I need add to them in great detail.

It is true that, as has just been said, the Budget's overall approach to business is neutral. It has probably been favourable to large companies and less favourable to small companies, for reasons that have already been given and particularly because of the impact of clause 3. However, what we say as Opposition spokesmen is less important than the way in which businesses themselves experience and perceive the changes. A fairly large survey conducted by the British Chambers of Commerce, which represents both large and small companies, concluded that 70 per cent. of United Kingdom businesses believed that the proposals would damage them, mainly because of the impact on small companies.

Let me deal with the two major arguments that have been advanced in defence of clause 3. The first, advanced by Helen Goodman, is the tax avoidance argument—the argument that large numbers of small entrepreneurs are constantly calculating, on the basis of the tax rate, the respective merits of taking their profits as salaries or as dividends. That may or may not be a valid point: we do not know. One of my questions to the Government is how much research they have actually done. There have been two major changes of policy, and I think it legitimate to ask how well the Government are informed by research and survey about how companies in this position behave.

The Economic Secretary asked Mr. Hoban whether he was going to change the policy. The hon. Gentleman gave a perfectly sensible answer, although I think he could have added to it. He said, "We would change the policy if we knew what was happening in terms of behaviour." The Government are rushing into tax changes without presenting any evidence about the way in which companies behave.

In evidence to the Select Committee, the CBI said:

"A claimed rationale for this decision was to reduce the differential between incorporated and unincorporated businesses. But in this case it is not clear why the corporation tax rate will end up above the personal income tax rate rather than being aligned with it."

If the purpose is to stop arbitrage at the boundary, why are the rates not being aligned? There may well be an answer to the CBI's question. If so, perhaps the Minister can explain what it is.

Photo of Vincent Cable Vincent Cable Shadow Chancellor of the Exchequer, Liberal Democrat Spokesperson (Treasury)

Indeed, but the wedge of national insurance is much larger than the 2 to 3 per cent. margins that the Government are playing with. We need some analysis of, and research on, how big the tax differentials need to be to change behaviour. We have been given no evidence so far.

The second argument relates to how far the clause 3 change in tax rates is offset by changes in tax allowances. You have advised us not to get involved in the details of tax allowances, Sir Alan, but the issue of offset is crucial to the debate. The argument is that the annual investment allowance will offset the increased tax burden for small companies. The Chief Secretary intervened to make that point. What we do not know—and I do not think the Government know—is how much of the annual investment allowance will be taken up by small incorporated companies. Can the Government give us an estimate? Are they thinking of 50 per cent., 30 per cent., 20 per cent., 10 per cent. or 5 per cent.? It would be useful to know the Government's internal estimates of how much is offset and how much is not.

Quite apart from the issue of how much is offset, there is the issue of the time lag between the two measures. The tax increase takes place immediately and in three successive stages, but the offsetting investment allowance is subject to consultation, and may or may not come into effect in two years' time. There is a gap between the two that will directly affect small companies.

Then there is the point made by several Members, particularly Mr. Dunne, about the impact differential between service companies, which do not engage in substantial capital investment, and manufacturing companies, which do. Finally, there is the much bigger question of the complicated interaction between the clause 3 increase in corporation tax, the annual investment allowance and the change in the capital allowance rules. All three will be swirling around together.

It is worth looking—although not in great detail—at the evidence that the Institute of Chartered Accountants in England and Wales devoted to the issue. I will just quote a couple of lines. It states:

"The changes to capital allowances will particularly impact small companies" because of the relationship with the tax change.

"This will particularly be the case for those that claim significant amounts as plant and machinery allowances and in respect of industrial buildings."

The institute continued:

"Examples of other family businesses that would be affected are printing companies, haulage businesses, manufacturing companies, etc. Such companies are likely to be significant businesses in the local community".

The complex inter-relationship between a tax increase and two big changes in allowances, taking place over different time horizons, will have complicated and, probably on balance, significantly negative effects for small companies.

The Government would therefore be wise to heed the advice of the Treasury Committee. The hon. Member for Fareham has already quoted its conclusion that the Government should initiate a review of the policy for next year's Finance Bill because of the unpredictable nature of the outcome, but it is worth while quoting another sentence from the conclusion. It states:

"It is not clear whether measures such as the increase in the R&D tax credit and the introduction of the Annual Investment Allowance will have the desired beneficial impact on investment levels by small companies."

In several interventions, Labour Members have asserted as a matter of dogma that the changes will increase investment, whereas the Treasury Committee, representing three parties, looked at the matter across the board and concluded that the results are likely to be entirely unpredictable. Therefore, I remain totally unpersuaded that clause 3 is justified in anything like its present form.

Photo of Michael Fallon Michael Fallon Chair, Treasury Sub-Committee 4:30 pm, 30th April 2007

I, too, oppose clause 3, for many of the reasons that were put forward by my hon. Friend Mr. Hoban and by Dr. Cable, whose comments I thoroughly endorse. The clause is misguided and discriminatory. It is distortive in its aim, although unlikely to be distortive in its effect. In the end it will damage many small businesses.

In justifying the clause, the Chancellor has stressed that its purpose is to prevent tax avoidance, but he has put forward no hard evidence since the Budget or indeed to the Select Committee that the great majority of small businesses are in the tax-avoidance game. That is a slur on most small businesses, and I am surprised that Helen Goodman simply assumes that those small businesses in her constituency that do not happen to be involved in manufacturing must be involved in tax evasion or tax avoidance. That is a slur on many hard-working small businesses across County Durham.

Photo of Michael Fallon Michael Fallon Chair, Treasury Sub-Committee

It is a slur that is so serious that I must give the hon. Lady the opportunity to reply.

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland

I am grateful to the hon. Gentleman for giving way. Nothing in my remarks could possibly lead any reasonable listener to conclude that that is what I was saying. That is not what I was saying. I was asserting that it is particularly important to support manufacturing industry and to protect the revenue base. The problem that we face is that the number of people who move to the incorporated sector is on the increase, so the tax base will be eroded further.

Photo of Michael Fallon Michael Fallon Chair, Treasury Sub-Committee

It is clear again that the hon. Lady—I do not know why she keeps beating up her own constituency—is implying that many businesses that are not involved in manufacturing are now being incorporated simply to avoid tax. She has used the word "many" and the Chancellor has used the word "many". However, neither of them have produced hard evidence. When we tackled the Chancellor himself on this question in the Select Committee, he said that it was not just a question of what had happened in the past. He said:

"people who are coming to work in this country are being encouraged to form, and work through, managed services companies even before they come into this country. We faced the prospect of schemes that are being marketed right across Eastern Europe, encouraging people to set up companies purely for the purposes of avoiding taxation".

In other words, the clause is based not simply on what has happened or is happening, but on what is likely to happen across Europe. We clearly do not have sufficient evidence to justify this change.

Secondly, I am opposed to the clause because, as was brought out in our questioning earlier today, it is discriminatory. It is not neutral in its effect. A vast number of small businesses are not involved in research and development. As my hon. Friend Mr. Dunne said, many small businesses do not rely on annual investment. Why? Because they are different types of businesses: they are people businesses, or skills businesses, or consultancies—or knowledge businesses. It is perverse of Ministers to prattle on about how they are supporting the knowledge economy and then to clobber those small businesses that are part of the knowledge economy but do not invest in old-fashioned plant and machinery and qualify for their new fancy allowances. There are knowledge businesses that will lose out because of this measure, so it is discriminatory.

Thirdly, I oppose the clause because its aim is distortive. The objective behind the clause is that Ministers want there to be more investment in research and development. Yet when we took evidence on that point, we were informed by Mr. Whiting

"that the changes to the taxation system in the 2007 Budget were unlikely to be behaviour-changing and that businesses tended to prefer a lower tax rate and simpler taxation system to incentives to invest."

There we have it—and from one of the experts. Small businesses know about research and development, and simply to encourage more of them to invest in research and development through a particular tax change is unlikely to be as effective as lowering the basic rate of tax that applies to small businesses and keeping it low rather than increasing it.

I am also opposed to the clause because it will be damaging. That is not my conclusion alone. As the hon. Member for Twickenham pointed out, it was the overall conclusion of the Treasury Committee, which contains a majority of Government Members and a handful of Opposition Members. The Labour-dominated Committee was so concerned at the lack of hard evidence in support of this proposal that we concluded:

"It is not clear whether measures such as the increase in the R&D tax credit and the introduction of the...Allowance will have the desired beneficial impact on investment levels by small companies."

That is why we recommended that, before the final changes are put into effect in the 2009 Budget, we have a proper review of the impact of the measures so that we can establish whether they are positive across the small business sector and whether they discriminate between different parts of that sector. Until that review has taken place, the House cannot possibly support the clause.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

As we are talking about corporation tax, I draw Members' attention to my entry in the Register of Members' Interests.

One of the keys to having fair taxation is stability. Robert Chote of the Institute for Fiscal Studies told the Treasury Committee during its hearing on the 2005 pre-Budget report:

"A little bit of stability in this area would now be welcome."

It is now two years later, and it would still be welcome.

Speaking during the debate on last year's Finance Bill, the Financial Secretary mentioned the responses that the Government had received to the consultation paper on the taxation of small business issued in 2004. He said that businesses had

"a strong preference for simplicity over approaches that risked introducing further complexity."—[ Hansard, 2 May 2006; Vol. 445, c. 926.]

That is a principle on which we can all agree, but it is not one that has much currency at the Treasury, it would seem. This year's Finance Bill has been reduced to one volume but, unfortunately, the House of Commons Library has had to produce two volumes of briefing notes on the taxation of small businesses—one covering changes between 2000 and 2006, and a second covering recent developments, which no doubt Rob Marris has perused in detail.

This is the third time that I have been involved in a Finance Bill debate, and I am already developing a sense of déjà vu. The first instalment of the phased increase of the small companies rate in clause 3 will push small businesses one step closer to where they started, before they were hit with a decade of chopping-and-changing confusion from the Chancellor. The reason for all this confusion is disarmingly simple: tax incentives originally intended to encourage business investment and business growth suddenly became perceived as loopholes. It is tempting to say that one man's incentive is another's loophole, but unfortunately the Chancellor's incentives always seem to become his loopholes if they are given a little time.

It did not matter that everyone warned the Chancellor that radical changes to the small companies rate would act as a direct incentive for incorporation; in fact, there has probably never been so many Cassandras offering unheeded prophecy. He went ahead anyway, and all the changes since then have attempted to restore a balance between incentivising small businesses and preventing the erosion of the tax base, both of which I can recognise as sane objectives on the Treasury's part. The IFS "green Budget" contained the plea that

"we can only hope that the Treasury will draw appropriate lessons from this unfortunate experience."

However, I question whether the lesson has actually been learned. For several years now, the reaction to the Chancellor's treatment of small business taxation has been dominated by one image: the U-turn. For a little variety, last year I dubbed the abolition of the non-corporate distribution rate a three-point turn. This year, it has become even clearer that the Chancellor is simply going round in circles.

However, my real concern is that providing incentives to small business is no longer front and centre in the Treasury's strategy, and that the emphasis has now shifted on to deciding whether using a tax incentive constitutes avoidance. It all comes back to the Chancellor's nebulous reasoning about what constitutes a "fair and appropriate" share of tax, or simply the "right amount" of tax. This is an unfocused way of looking at the broader issue of what small businesses contribute to the economy and what the Government should do to help them. The Paymaster General, unfortunately, she is not with us today, said back in 2004, in the middle of the long-winded debacle surrounding the small companies rate, that

"The deliberate and cumulative aim is to underpin all the measures that the Government have taken to encourage businesses to grow and to be more enterprising and productive in the medium and long term and not to operate year by year by playing around with the tax system."—[ Hansard, 27 April 2004; Vol. 420, c. 846.]

On that point, I have to agree with her; indeed, that is a more useful guiding principle and intention.

However, we would be forgiven for thinking that there is something wrong with the Treasury's deliberation, and that its policies have not been cumulative at all. Certainty and continuity in the tax system are helpful to all businesses but particularly small ones, which have less capacity to adapt quickly or take specialist tax advice. The rate changes and forthcoming proposals for a new annual investment allowance only deepen the artificial gulf between small businesses and larger firms.

The Chancellor has in fact taken the muddle of the small companies rate and created a paradox. Reducing the main rate of corporation tax and capital allowances leads to a cut in the tax rate and to an increase in the tax base for larger businesses. However, small businesses are being pulled in the opposite direction through an increase in the tax rate and a narrowing of the tax base, because fewer businesses will be able to make full use of the new investment allowances of which we have heard much during this afternoon's debate. The Chancellor has made the fatal assumption that because all small businesses, in whatever sector, will theoretically be able to make use of the investment allowance, all will do so. That was the justification he gave to my hon. Friend Peter Viggers during the Treasury Committee's inquiry. The Chancellor also defended the changes on the grounds that they appear to be revenue-neutral—perhaps that is just another example of a tax cut being a tax con. However, even if we are inclined to accept that reasoning, the AIA will not take effect until next year, leaving a guaranteed tax rise over the next year.

I want to probe behind the modelling that led to the assumption of revenue neutrality and establish exactly how many of the UK's 1.3 million incorporated businesses are expected to make use of the allowance and to what extent. Perhaps the information will be forthcoming later when the Minister responds to the debate.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West 4:45 pm, 30th April 2007

The hon. Gentleman talked about phasing in the allowance, but he also said that there would be a tax rise this year. He is right, but we need to keep things in perspective. My understanding is that the tax rise will be the relatively—I stress that word—small amount of £10 million a year, which is only £2 per small business.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

I always appreciate the hon. Gentleman's interventions, but small businesses operate on the margins so £1,000—even £500—can make a huge difference. Unfortunately, the provision demonstrates yet again the Labour Government's lack of understanding of how small businesses actually work and survive from day to day.

I am only hazarding a guess, but if too many businesses make use of the annual investment allowance they could sow the seeds of the Government's next anti-avoidance strategy. Businesses that invest will come to be seen as cheating. In the words of the Federation of Small Businesses:

"It is amazing how quickly a concession to encourage enterprise can become a loophole."

In our report on the Budget, the Treasury Committee admitted:

"It is not clear whether measures such as the increase in the R&D tax credit and the introduction of the Annual Investment Allowance will have the desired beneficial impact on investment levels by small companies."

That is the very point made by my hon. Friend Mr. Fallon earlier. We suggested that the Treasury should take stock of the impact of those changes before the 2009 Budget.

I would go a little further. If the Government are looking for a positive signal to send to small businesses, and for a policy that will have no new unintended consequences, there is one simple answer: leave the small companies rate well alone for a year or so and let small businesses and their accountants catch their breath.

Photo of David Gauke David Gauke Conservative, South West Hertfordshire

I, too, oppose clause 3 for the reasons outlined by earlier speakers, but I want to explore the Government's thinking a little further and ask some questions about their approach to the small corporation tax rate.

As Helen Goodman said, there is an issue about the two different tax regimes that may apply to a small business. As my hon. Friend Mr. Hoban said, if the business can be taxed as income, it will pay income tax and national insurance contributions, whereas if it is taxed as a company, it will pay corporation tax, so there can be distortions, as I would be the first to acknowledge. However, I am curious about whether the Government's approach, as outlined in clause 3, is to make the system as tax-neutral as possible and to remove any distortion—if that is the right word—between the two systems. If so, there are a number of further questions.

Do the Government acknowledge that their previous approach to the zero rate of corporation tax was wrong? It undoubtedly created an incentive for small businesses to incorporate and there was a substantial increase in incorporations. In 2001, 220,000 companies were incorporated; by 2003, the number had risen to 397,000. Undoubtedly, the zero rate of corporation tax contributed to that. As to the point made by Rob Marris in an earlier intervention about the need to disaggregate incorporations between companies and limited liability partnerships, I happen to have the numbers to hand. In fact, limited liability partnerships have made a very small contribution. In 2005-06, there were 6,570 incorporations for LLPs, whereas there were 372,000 for limited companies. Clearly, LLPs are not a substantially large part of it. The tax system has undoubtedly contributed to that position.

If it were the Government's intention to take away any tax advantage from incorporation vis-à-vis non-incorporation, their approach has been incoherent. Let us consider this Budget alone, where changes to national insurance contributions and higher rate thresholds for income tax further encouraged businesses to incorporate. There is a larger and wider standard rate of income tax and no additional income tax to be paid on dividends within the rate, yet national insurance contributions now cover a larger area, which is where the advantage lies. Dr. Cable raised the matter of aligning corporation tax with income tax, but there is still a difference with national insurance contributions—a problem that has got worse as a consequence of the Budget. There appears to be an incoherence in the Government's approach.

A number of hon. Members, and particularly my hon. Friend Mr. Fallon, dealt with businesses that fall outside the various permitted reliefs and allowances. Again, I question Government thinking in this area. When they introduced the zero rate band, they argued that it would encourage growth and entrepreneurial spirit, which are commendable. They then scrapped the zero rate band because it was over-used. The argument may be that it was used by businesses that were not looking for growth and a more entrepreneurial approach.

Are the Government saying that the only small businesses likely to grow to create jobs and become entrepreneurial businesses are those that can use the capital allowances? If so, that seems to be entirely misconceived. It is not possible to identify a particular type of small business that is likely to be high growth. It simply does not work like that, because many service industries or high-technology businesses might not require great capital investment, but they could still be the big employers of the future. It seems to me that the Government are adopting a rough-and-ready approach to addressing this particular concern.

My final point concerns the bureaucracy imposed on small businesses. My hon. Friend the Member for Fareham mentioned that research and development credit take-up tends to be very low. The reason is undoubtedly that it is difficult to claim, complicated and requires a great deal of effort. Inevitably, small businesses are not in as strong a position to respond as larger businesses. Providing greater allowances that are often hard to claim is not an adequate way of trying to mitigate the increase in tax rates. Whatever way one looks at it, it is not good for small businesses. I am afraid that pointing to the existence of those allowances—I appreciate why we cannot dwell on this particular point—amounts to a poor argument.

In conclusion, the tax changes appear to be incoherent and they do not address the problem that the Government themselves recognise. We are still left with difficulties in this area.

Photo of Philip Dunne Philip Dunne Conservative, Ludlow

I am conscious that the debate on clause 3 has gone on for some time and I do not intend to prolong it unduly. I will just reiterate some of the points that have been made by other hon. Members. In the context of one of the Budget's declared aims, the Finance Bill provides clear evidence that the Chancellor seeks to impose a regime for small and medium-sized businesses that is not good for business. The regime is prohibitive for business. It will restrain and restrict business from generating the profits that it needs to reinvest by increasing the taxation take to the Chancellor—to the public purse. Essentially, the corporation tax increase for small business is funding the corporation tax cut for large business, but when taken in the round with the other measures—I will not try your patience any longer by straying from the clause, Sir Alan—the burden on business as a whole is significantly increased. That is a result of the clause and other measures in the Bill, and other measures outside the Bill that will have a significant impact on individual businesses.

Let us consider the Chancellor's claim to be a business-friendly Chancellor after 10 years, given that he has introduced a taxation regime that, as we have heard from other speakers in the debate, has involved a complete volte-face. We have had measures to encourage the incorporation of businesses and now we have measures to discourage the incorporation of businesses. Businesses look for stability in tax planning. Many investment decisions—including those that I am not able to refer to—require some understanding or expectation that the tax regime will have stability for a number of years so that businesses can take advantage of the measures that give those opportunities. If the tax regime is tinkered with to the degree that it has been by this Chancellor—so frequently; year in, year out—the stability is not there, making those decisions becomes increasingly difficult, and there is a lack of trust in the conduct of taxation policy. I am afraid that this Finance Bill helps to stoke up that lack of trust.

My hon. Friend Mr. Hoban and other hon. Members have quoted some of the public responses to the measures and to this clause in particular. One response that struck me—I do not think that it has been mentioned so far—came from a survey conducted by the Forum of Private Business on its website. Some 82 per cent. of respondents to the survey felt that the corporation tax hike for small businesses would be damaging to their business. The Financial Secretary cannot ignore that statistic. I look forward to his response when he sums up.

Photo of Colin Breed Colin Breed Shadow Minister, Treasury

I want to build on some of the remarks made by my hon. Friend Julia Goldsworthy. Cornwall was fortunate—if we look at it one way—in achieving objective 1 status a few years ago. On the back of that, we had the wonderful opportunity to develop the combined universities in Cornwall to try to build some of the knowledge base and future GDP of the county, and to build up the economy. Much of that was going to be centred around relatively fledgling businesses in new knowledge-based industries, such as renewable energy, IT consultancy and marketing. Many of those small businesses have just started. They really are fledgling in that sense. Their business plans would have been predicated on certain assumptions about the tax that the businesses would be paying.

Those businesses are perhaps two or three years old now. They are not capital-intensive businesses, but they tend to want to employ relatively expensive new personnel. When new personnel come into a company, they are not immediately productive, but, of course, their salaries and their expenses have to be paid out by the company. Some of the small businesses are going to begin to stutter a little when it comes to their ability to fund some of that revenue, which would have been thought to come from the profits that they would initially begin to generate. That will no longer be the case, because some of that money will have to be paid in tax.

It is part of the issue about stability that when people are looking to create their business plans and looking to the quite considerable growth of these sorts of businesses, they consider the expenses that they will have to pay. Tax is one such expense. They would undoubtedly have made their business plans on the basis that they would not be paying tax quite as quickly as they are now going to be. I think that that will stunt some potential growth and undermine investment from European objective 1 funding. The investment's new guise of convergence funding is even more tilted towards such businesses, rather than the old capital-intensive businesses. That funding is designed to generate more knowledge-based industries. If we are to have this new tax regime, the real benefit of boosting the economy of Cornwall, which is the essence of convergence funding, will be undermined.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West 5:00 pm, 30th April 2007

What a fascinating debate. I understand why Conservative Members have spent a lot of time on this because small business is important. They talk about damage to competitiveness, yet they also say, quite properly, that the changes will largely affect service companies, which make up 75 per cent. of the small business economy. I suspect that few small service companies export much, so the competitors are medium-sized and big companies. It is surprising, given what Conservative Members have said, that the Conservative party is turning against big and medium-sized business, putting forward a positively Poujadist approach and making a fetish of small businesses.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

It is somewhat extraordinary that the hon. Gentleman is arguing that service businesses, especially small service businesses, tend not to export. Several small service businesses in my constituency export a great deal overseas. The measure will thus have an impact on their competitiveness. He needs to be careful about the assertions that he is making about the propensity of small businesses to export.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

In one sense, the hon. Gentleman might be right, but, in another sense, he is completely wrong. A small business cannot export a great deal because, of course, it would therefore not be a small business. However, such a business might export a large proportion of its output. I was careful to say that I suspect that most small businesses in the service sector do not export a great deal.

During the interesting remarks made by Mr. Fallon, he used the adjective "distortive", which was a new word to me. I entirely reject the approach to economics that he cited, which is based on a view that is peddled by academic economists of the worst sort: that there is such a thing as a perfect market and that that perfect market can thus be distorted. If one rejects the notion that there is such a thing as a perfect market, as I do, there is no such thing as distortion in this context, although there is such a thing as changed behaviour, or certain effects stemming from certain causes.

Changed behaviour that is driven by a tax regime is nothing new in the United Kingdom. It is often the subject of considerable debate on financial measures relating to green taxes. If the Chancellor proposes fiscal measures to encourage a change in behaviour, that is not wrong in principle, although hon. Members might think that the measures will not produce the desired effect, or that the effect that the Chancellor is trying to achieve is not one that they desire. However, I reject the suggestion—this has been the flavour of part of the debate—that the fiscal measures to change behaviour that are proposed in the clause are somehow, in and of themselves, bad things.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

I have two questions for the hon. Gentleman. First, how will it be possible for a service company—the majority of small businesses are service companies—that is not capital intensive to change its behaviour under the scheme? Secondly, why are manufacturing or capital-intensive businesses any more deserving of tax incentives than those in the service sector?

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

I can deal with the second point. As a Member for a west midlands constituency, I am aware that the vast majority of UK exports come from the manufacturing sector and not from the service sector. Important as the service sector might be to exports, about 56 per cent. of the value of exports comes from manufacturing.

Photo of Theresa Villiers Theresa Villiers Shadow Chief Secretary to the Treasury

Does the hon. Gentleman not believe that the City is responsible for a vast amount of our invisible exports?

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

No, it is responsible for invisibles; as the hon. Lady should know— [Interruption.] They are not exports but invisibles, which are a different category in economic terms. Although they go on the balance of payments, they do not go on the balance of trade, so I stand by what I said in response to Mr. Newmark. He asked why manufacturing should have special support, and that is one reason I give him. He might not like it, but I stand by it: the majority of exports in terms of the balance of trade come from manufacturing.

I shall come on to the hon. Gentleman's first point about manufacturing. The hon. Member for Sevenoaks cited comments made by Mr. Whiting. He is quoted in the Treasury Committee report as saying words to the effect that most businesses prefer simpler and lower taxes—I hope that he will forgive me for not having the exact wording before me, although that was broadly what he said, and I believe that he used those two adjectives. I am sure that they do. I have no direct evidence for that, other than anecdotal evidence gained from talking to business people.

The evidence is plain for all to see that in the United Kingdom for the past 100 years, until recently—even now the situation has not changed enough—as a generalisation, there has been huge underinvestment by businesses, be that in the service sector or in the manufacturing sector. I stress that that is a generalisation. It is one thing that has led to weak economic performance in the United Kingdom from the turn of the previous century for the following 90 or 100 years. Encouraging changes of behaviour that will lead to greater investment is a good thing. I share that desired aim of the Chancellor, as I suspect does the hon. Member for Sevenoaks.

Photo of Helen Goodman Helen Goodman Labour, Bishop Auckland

Does my hon. Friend agree that it is extraordinary that Conservative Members are making such a fuss about a rise to 20 per cent. in the small companies rate? My recollection is that when the Conservatives were in power the rate was 23 per cent.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

I accept the figure given by my hon. Friend, although I do not know whether the rate was 23 per cent. or not. I hope that Mr. Hoban will correct me should I have this wrong, but I believe that he was talking about certain allowances producing an effect on 4.3 million businesses; he cited a figure of £68. Yet in year three of the changes before us—this is the figure that he did not give us in regard to those 4.3 million small businesses—the increased tax take will, on average, be £190.70 per small business. I have rounded that figure slightly. That represents £820 million given in year three divided by the 4.3 million.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

The hon. Gentleman commits the same mistake as Kitty Ussher. The increase in the small companies corporation tax rate simply applies to the number of incorporated companies, whereas he has used the number of small businesses. If he were to divide the increased tax take by the number of small companies—some 800,000 of which are profitable—he would find that the average increase is £1,000 per small company. I accept that this is a difficult issue; there is confusion in respect of small businesses and small companies. I might have made the same mistake inadvertently, but it is important to distinguish between the two when we consider the gainers and the losers from these measures.

Photo of Rob Marris Rob Marris Labour, Wolverhampton South West

I am grateful for the hon. Gentleman's extremely helpful intervention. Having been in small business myself, I accept that £1,000 is significant to such businesses. Given that many of us wish to encourage small business to grow, it surprises me that this whole clause stand part debate seems to have been a subsection (1) stand part debate. No reference has been made to subsection (2) and the following subsections in terms of marginal reliefs. They relate to the transitional provisions in terms of corporation tax for those companies whose profits are between £300,000 and £1.5 million per annum. They are the lower and upper profit limits for what one might call the transitional regime for the rate of corporation tax. That should benefit what one might call larger small business. I use that term rather than medium-sized business because a business may well grow to reach the level of profitability and therefore the tax bracket covering companies with profits between £300,000 and £1.5 million without crossing the threshold in terms of the number of employees that would result in its being a medium-sized business.

I also note that in response to the intervention by my hon. Friend the Financial Secretary, the hon. Member for Fareham did not say what he thought the rate should be. His response, broadly—I paraphrase, but he will correct me if I have it wrong—was, "We're not in government now. We'll look at it when we are in government in 2010." That was certainly the year he cited. However, it surprises me that, even though he feels so strongly about subsection (1), which deals with the 20 per cent. rate instead of the zero rate for small companies, he has not tabled an amendment. If he did table one, he will have to forgive me for saying that, but I have not seen it listed—perhaps it was not selected. If the hon. Gentleman speaks again in this debate, will he say whether he proposes to vote against clause 3 given that, although it contains a provision that he regards as somewhat negative in subsection (1), it later sets out a measure that I suspect he regards as positive?

Photo of John Healey John Healey The Financial Secretary to the Treasury

We have had a useful and wide-ranging debate that has served to bring out some of the broader issues in the light of which it is necessary to consider clause 3. If you will allow me, Sir Alan, I shall set out those issues as a way of helping hon. Members to consider the provisions of clause 3 in the proper context.

Mr. Hoban admitted to having made a mistake that his right hon. Member for Witney (Mr. Cameron) has also made. In fact, there are 4.3 million small businesses in this country, more than three quarters of which are not incorporated, are not small companies and are therefore not subject to the corporation tax regime. They will not be affected by the changes in clause 3, and it is important to recognise that. Furthermore, one in four of those that are incorporated and are therefore small companies currently pay no corporation tax and are unaffected by the changes because they are not making a profit. The hon. Gentleman acknowledged that in this debate, although not on Second Reading.

An important point, which affects the hon. Gentleman's argument, is that we estimate that the majority of the small companies that remain have incorporated with the purpose of reducing their tax and national insurance liabilities. In other words, those companies take a tax relief that is aimed at investment and growth to reduce their personal tax and national insurance contributions liabilities. In contrast, all small businesses, both self-employed and incorporated—all 4.3 million—can benefit from the associated announcement in the Budget of the new annual investment allowance for expenditure up to £50,000, which many hon. Members have mentioned this afternoon. Many of the self-employed businesses will also benefit from the personal tax changes announced in the Budget.

If we look more closely at the companies that could be affected by the changes to the small companies rate, we find that in 2004-05 some 750,000 companies paid what is known as the small companies rate, which is really a small profits rate because any company with profits of up to £300,000 in a year benefits from that low corporate tax rate. In fact, a quarter of large companies—those employing more than 250 staff—pay the small companies or small profits rate; and fully around half of medium-sized companies, which have between 50 and 250 employees, pay that rate. The question as regards future tax decisions and reforms is whether we should continue, through the small companies rate, to provide a low rate of corporation tax targeted on low-profit companies, regardless of their investment activity. That fundamental principle underpinned the package of decisions that we announced in the Budget and that we are now incorporating in law through the Finance Bill.

Since the late 1990s, we have looked carefully at small business taxation, with a view to ensuring a tax system that encourages investment and innovation and provides the fairest possible outcome for all small businesses. Dr. Cable said at one point that he thought that we were rushing into making the changes. He carries out his duties diligently, so I am sure that he will have read the consultation document that we published in December 2004, "Small companies, the self-employed and the tax system". It encouraged a wide-ranging debate on how incentives for growth and enterprise can be best targeted while maintaining a system that is as fair as possible for all. The package of changes that we are proposing is a response to that debate, and it comes after careful consideration and detailed discussions with a wide range of interested groups.

One of the factors that we have to take into account is the degree of tax-motivated incorporation. Lower rates of tax have resulted in a significant number of people incorporating to take advantage of those low rates, not to reinvest in the business, but to extract the company profits in a way that reduces their personal tax and national insurance liabilities, while still allowing them access to contributed benefits. That is contrary to the aims of the reforms that we made to the small companies rate in previous years. Of course, the costs to the public purse are significant; clearly, if all self-employed people decided to incorporate, it could cost the Exchequer billions of pounds in lost revenue, and it would do little to improve productivity or growth. That tax break would be subsidised by ordinary taxpayers and self-employed businesses, which would suffer a competitive disadvantage.

We propose, in part through clause 3, to refocus the manner in which we provide investment incentives to small businesses. All the revenue raised by the small companies rate increases will be recycled back into small businesses. First, the increase in the small companies rate will reduce the difference in the tax paid by the incorporated and the self-employed. As Members may know, one noted commentator and academic, having considered the impact of the Budget changes on the tax incentive to incorporate, has said on accountingweb.co.uk that there is

"probably insufficient reason to incorporate at profits of less than £40,000 in the future".

Secondly, the headline small companies research and development tax credit will increase from 150 per cent. to 175 per cent., which will help small companies, particularly those investing in innovation and new technology. The current first-year capital allowances for small firms will continue at 50 per cent. for a further year. Finally, from April next year, the annual investment allowance will target assistance directly at businesses that invest their profits, regardless of legal form. Under our package of changes, the amount of investment does not have to be significant for a small company to benefit. Some 90 per cent. of tax-paying companies will pay less in tax in the first year in which the annual investment allowance comes into effect if they reinvest as little as 23 per cent. of their profits in their business.

We know that for many small companies and businesses, whatever their legal form, cash flow is king, and that is part of the reason for the annual investment allowance. Cash flow poses the principal risk and is the principal pressure. At present—Mr. Breed was concerned about this—labour costs are fully deductible. Employees' wages and employers' national insurance contributions are deductible from, and offset against, taxable profits. The annual investment allowance provides parity between capital and non-capital expenditure precisely in that way.

The hon. Member for Twickenham wondered how much of the annual investment allowance would go to small businesses. We calculate that about 90 per cent. of the cost of the annual investment allowance will go to small businesses. For example, in the financial year 2009-10, we estimate the cost of the AIA to be about £920 million, of which an estimated £805 million will go to small firms. We will obviously monitor that, and evaluate it once it has been introduced. May I tell the Committee, too, that the notion that somehow small businesses do not invest is far from the mark? In the last year for which we have firm figures, small companies invested some £6.4 billion in capital expenditure, and we expect the vast majority of small businesses making a capital investment to claim the AIA in future.

Perhaps we should dwell, too, on the perception—this argument has been made by the Opposition this afternoon—that service companies do not invest, either. Based on the analysis of data by Her Majesty's Revenue and Customs, well over a third of small companies in the businesses service sector invest. Unincorporated businesses in the sector that do invest, invest an average of £3,500 a year. Small companies in the sector invest an average of £22,000 a year. Other service sectors demonstrate perhaps even higher levels of investment. More than half of service firms in the retail sector invest, and more than half of businesses in the hotel and catering sector do so.

Photo of John Healey John Healey The Financial Secretary to the Treasury

I shall give way to the hon. Gentleman, because he was very active in the debate.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

I listened very carefully to the explanation of the incentives driving the policy. The Minister said that a third of small businesses will benefit, but that still means that the majority—two thirds—will not do so. Will he comment on that?

Photo of John Healey John Healey The Financial Secretary to the Treasury

I was not talking about all service companies; I was talking specifically about the business services sector. I went on to say that more than half the service companies in hotel and catering and more than half the companies in retails invest, and do so consistently. A small catering company, for instance, that makes £100,000 profits and invests £30,000 in new kitchen equipment, will pay about £2,000 less tax in the first year of the new annual investment allowance than it would do without the changes in the Budget. A self-employed builder who invests £4,000 to start up a business and earns £30,000 in the first year, will pay about £1,200 less tax and national insurance.

The hon. Member for Fareham, whose concerns were echoed by his hon. Friend Mr. Gauke, repeated the allegation that the package of changes will make the system more complex for small businesses, but the changes to the small companies rate in clause 3 do not make any difference to the level of complexity. The annual investment allowance, in fact, makes tax simpler for small businesses. If the hon. Member for Fareham will not take it from me, perhaps he will take it from the chairman of the tax committee of the Federation of Small Businesses, Simon Sweetman, who said:

"The Annual Investment Allowance...should allow what is in effect free depreciation for small businesses on plant and machinery, and has the added benefit of being a simplification."

Photo of Julia Goldsworthy Julia Goldsworthy Shadow Chief Secretary To the Treasury, Treasury

I am listening carefully to the Minister's arguments, but surely there is still a fundamental problem, as the small companies rate will go up now, but the annual investment allowance will be introduced next year. If we are to allow companies to prepare for the changes and make sure that they can offset as he described, would it not be better to introduce the changes simultaneously?

Photo of John Healey John Healey The Financial Secretary to the Treasury

The hon. Lady is right that there is a package of changes. I am sure she wants us to get the annual investment allowance correct when we introduce it next year, but she may have missed the point that I made earlier, when I said that for a further year—this year—alongside this increase in the small companies rate, the capital relief for small businesses that are investing will be maintained at the higher rate of 50 per cent. That helps to deal with her concern.

The package of changes, including clause 3, refocuses the incentives for investment, creates a simpler system that recognises the importance of cash flow in small companies, particularly those making capital investment, and reduces the unfair differential between businesses operating as self-employed businesses and those that choose to incorporate. I hope that, having heard the breadth of the arguments, the hon. Member for Fareham will not press the matter to a Division. If he tries not to allow clause 3 to stand part, I shall have to ask my hon. Friends to ensure that the clause, as an important part of the package of changes that the Chancellor announced in the Budget, remains part of the Bill.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

It has been a wide-ranging debate, reflecting the nature of the arguments used by the Government to support the increase in the small companies rate of corporation tax and the breadth of opposition to that policy. The Minister set out the argument that the Government made a mistake in 2002, when they discriminated in favour of incorporation by introducing the zero per cent. rate of corporation tax. They now seek to reverse that measure by raising the small companies rate. That will have an impact on a wide range of businesses making profits of up to £1.5 million.

We see a wide-ranging attack on those small companies and an increase in the tax that they will pay. The numbers speak for themselves. There will be an £820 million increase in the tax take from those small businesses, equivalent to £1,000 per company, yet the benefit of the offsetting package amounts to about £60 per small businesses, so businesses will be hit hard. Small companies will see an increase in their tax bill, without the offset.

As the Financial Secretary indicated, businesses that do not seek to invest in assets will be penalised. They will not benefit from the increased capital allowances on offer. There is discrimination against businesses that seek to grow by employing more staff and against knowledge-based companies. A great bias seems to be developing in the arguments put by Labour Members against the service sector, which, according to the hon. Member for Wolverhampton, South-West, (Rob Morris) does not contribute much towards exports, whereas we know that service sector businesses of all sizes make a major contribution towards exports. A large number of them export a significant amount of their turnover and play an active role in exploiting those markets.

The measure is ill thought through and ill conceived. Since the Government were elected in 1997, the large number of changes to the small companies corporation tax rate have sent out a mixed message to those companies. When they see the large companies rate of corporation tax being cut in the Budget, they wonder what the Chancellor thinks small companies are up to. They feel that the Government do not take them seriously and do not believe that they are the backbone of the economy and an important job and wealth creator. For that reason, I propose that we vote against clause 3 stand part.

Question put, That the clause stand part of the Bill:—

The Committee divided: Ayes 257, Noes 138.

Division number 102 Orders of the Day — Clause 3 — Small companies' rates and fractions for financial year 2007

Aye: 257 MPs

No: 138 MPs

Ayes: A-Z by last name

Tellers

Nos: A-Z by last name

Tellers

Question accordingly agreed to.

Clause 3 ordered to stand part of the Bill.