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

Orders of the Day – in the House of Commons at 10:00 pm on 25th June 2007.

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Votes in this debate

Photo of Michael Martin Michael Martin Chair, Speaker's Committee on the Electoral Commission, Speaker of the House of Commons

With this it will be convenient to discuss the following amendments: No. 41, page 2, line 11, leave out from '20%' to end of line 12 and insert

'for companies with non-ring fenced profits employing fewer than five people, and

(b) 19% for companies with either ring fence profits or five or more employees.'.

No. 42, page 2, line 14, leave out from second 'profits' to 'fraction' in line 17 and insert:

'and companies employing fewer than five people and with non-ring fenced profits ("the smaller company fraction"), and

(b) 11/400ths in relation to ring-fence profits of companies and companies employing five or more people ("the standard'.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury)

It is difficult to understate the mess into which the Government have got themselves on the taxation of small companies. After 11 Budgets and multiple rate changes, the Chancellor has almost come full circle on the subject. When the Government came to office, the 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, 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 rate was increased from 19 to 20 per cent.; next year it will increase from 20p to 21p, and the following year, it will go up from 21p to 22p. By the next general election, the small companies rate will be only a penny less than it was in 1997. There have been so many changes, yet so little progress. Eight tax changes have been made, simply for the rate to fall by only 1p in the past 10 years.

That constant meddling in the small companies rate reflects a problem at the heart of the Government's tax policy. Treasury Ministers perceive tax as a means of behavioural change; sometimes it might work and sometimes it does not. However, in 2002 some bright spark at the Treasury decided to stimulate enterprise by reducing the starting rate of corporation tax to zero. We know that that stimulated incorporation; hence the changes in later years to the starting rates, and their effects, until last year's abolition.

In the debate in the Committee of the whole House, Rob Marris and I referred to proceedings on Second Reading of the Finance Act 2002. We both admitted that our memory was rather hazy, but I checked the debate and I found a quote, in which I thought that hon. Members might be interested. It is:

"As a result, many small unincorporated businesses, such as plumbers, small builders or shopkeepers, think that they should incorporate because the tax position has become so advantageous for them...The Federation of Small Businesses asked whether that was a deliberate policy of the Government. The Inland Revenue assured the federation that the policy was deliberate and was intended to encourage enterprise. However, I am at a loss to understand how incorporation in itself is an encouragement to enterprise. I should have thought that we should be encouraging small businesses to be set up according to whichever format suited them rather than directing them—as the goal of Government policy—towards incorporation."—[ Hansard, 30 April 2002; Vol. 384, c. 895.]

Even in 2002, some people identified the potential problem. Hon. Members may wish to know who made that speech; I must confess, with some modesty, that it was me. The Government were, therefore, warned about what might happen if the policy went ahead.

The Government, in trying to remove the incentives, have gone into overdrive by creating the position whereby by the next general election, the small companies rate of taxation will be 2p higher than the basic rate of tax. The measure's impact on companies is crude. It is worth going back to the debate on this Bill in the Committee of the whole House, when the Financial Secretary said:

"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."—[ Hansard, 30 April 2007; Vol. 459, c. 1266.]

A measure that was apparently supposed to deal with unincorporated businesses becoming limited companies will lead to increases in the tax rate paid by 13,000 medium-sized companies and about 1,500 large companies.

In the spirit of consensus, may I offer to help the Government out of the hole they have got themselves into by increasing the tax rate on many businesses employing more than 50 staff? In amendments Nos. 41 and 42, they have an opportunity to focus the measure more effectively on the smallest companies, which they believe responded to their policy in 2002 to incorporate.

What is the Government's justification for the measure? What are they using to defend that change of tax policy? The Budget note on corporation tax reform summarised the argument succinctly by setting out three main objectives of reform: enhancing the international competitiveness of UK-based business; encouraging growth through investment and innovation; and ensuring fairness across the tax system. Those are laudable objectives, but let us look more carefully at what they mean in practice for small business. The cut in mainstream corporation tax, which we support, aims to improve Britain's international competitiveness, but only for companies earning profits of more than £300,000 a year. The Government's attitude is, "If you earn profits lower than that, tough." The Budget has worsened the position of such companies.

I suspect that the Financial Secretary will argue, as he did in the Committee of the whole House, that in the Budget there are changes to the annual investment allowance that will help small companies. However, that depends on businesses making decisions to invest in plant and machinery rather than in human capital. Small businesses that expected to earn the industrial buildings allowance or the agricultural buildings allowance will be hit hard by measures that we will discuss tomorrow.

The Government use the argument of fairness to justify the increase in the small companies tax rate, but I have established that it is a crude, clunking measure that hits companies of all sizes. There is a problem at the heart of the tax change, as the Government do not understand properly how small businesses work and how they are affected by the tax system. If they did, perhaps they would not be in this mess in the first place. It appears from representations made by small business groups that they do not believe that the Government understand them, either. Carol Undy of the Federation of Small Businesses was reported as saying:

"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."

About the Chancellor's tax changes, the federation said:

"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 spoke out against the small companies corporation tax increase:

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

Small business organisations clearly understand, as the Treasury does not, the impact of the increase on their members and their ability to invest and grow in future. The Government have sent mixed messages for business in the Budget, and it is time for a consistent approach to company taxation. Cutting one rate but increasing another sends a confused signal to the business world. It is right to encourage businesses to grow and invest, so it is wrong for the Chancellor, who did the right thing for companies earning large profits by cutting the headline rate of corporation tax, to increase the small companies rate. Because of the mistakes that he made in the past, he is penalising all small companies that pay that rate. Why should companies suffer because he got it wrong? The Government owe them an apology, not a tax increase.

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

I shall be brief. We have covered many of these issues on Second Reading, in the Committee of the whole House and in the Public Bill Committee. The only point that I wish to make, in addition to those made by Mr. Hoban, ties in with the previous debate.

It is not yet clear to many businesses how their tax treatment will be affected by the increase in the small business rate of corporation tax, the capital allowances and the research and development tax credits that may be available to them. Again, it would be helpful if, at the time of the Budget, information was published about what the differential impact of all the changes, in the round, will be—over time, as not all the changes occur within the same time frame; over sector, because we have heard that some capital-intensive businesses will benefit disproportionately; and by region, because in my part of the world, down in Cornwall and across the south-west, there are a disproportionate number of very small businesses. If many small businesses encounter a tax hike, areas with the highest proportion of small businesses will see that driver of their economy affected more negatively than other areas that have more big businesses or more capital-intensive businesses.

Businesses are still trying to work out how the changes will affect them, and what advantages and disadvantages there will be for them in the tax changes in the Budget and the Bill. I hope the Minister will give us an assurance that by the end of the debate on the Bill, businesses will have a clearer sense of what it will mean for them.

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

As Julia Goldsworthy said, we have covered much of the ground before, several times since the Budget, and we have rehearsed many of the general arguments in debates on the Bill and elsewhere. The arguments that I heard this evening from Mr. Hoban are fundamentally flawed, first in the proposition that there should be a differential in how the small companies rate is charged, and secondly, in the way that he attempted to target those rates.

There are huge practical difficulties with attempting to fix a tax rate based on fairly arbitrary and easily manipulated criteria, such as employment figures. What is the rationale for choosing five employees as representing a real company, rather than, say, six or four? What if employment levels change throughout the year? Would a company wait until after it had filed its tax returns to cut the work force? Would it take on temporary workers in order to get above the magic level of five employees?

On a more serious level, one needs to consider the risk of distorting what should be commercial decisions because of a tax structure. That would create incentives for small companies to merge not for commercial reasons, but for tax reasons. It would also be an incentive to exaggerate employment levels in the company. The proposition is seriously flawed in a number of ways.

The core of the problem is not the practicality of introducing such arbitrary measures, but the rationale for doing so. To encourage investment, as the hon. Member for Fareham recognised, the Government have looked to reduce corporation tax rates successively since 1997, to the extent that even when we reverse that trend and return the small companies rate to 22 per cent., it will be still be lower than when we came into office in 1997. The hon. Gentleman acknowledged that earlier.

The hon. Gentleman criticised us for what he termed constant meddling with the rates, but at each stage what we have done, and the rationale for doing it, have been clearly set out. At each stage we have said that the changes that we are making in the rates were to encourage retention, reinvestment and growth. As with all elements of the tax system, we have made it clear that we would keep those changes under careful and constant review.

As hon. Members have recognised, the earlier changes and their impact were not as we intended. We saw an increase in incorporation taking place, not as a launch pad for growth but as a way of reducing personal tax and national insurance levels, while in many cases those involved were carrying out exactly the same economic activity as before.

That is why we decided to change the way in which we focus incentives for growth, and we have changed the focus, not for some businesses, or those with fewer than five employees, but for all businesses—not just companies, but those that are unincorporated as well. The hon. Member for Fareham cited the Federation of Small Businesses, and I shall do so too, as I have in previous debates. It has welcomed the proposal for the annual investment allowance, which will benefit the direct activity of investment. By providing an allowance of up to £50,000 for all businesses, the arrangement will cover all the yearly expenditure of about 19 out of 20 small businesses, effectively providing them with 100 per cent. first-year allowances, moving towards a cash-flow tax system, dealing with what many small businesses constantly say is their biggest problem—their tax-flow levels. Even modest levels of investment in plant and machinery will bring significant benefits.

We recognise that there are many sound reasons for incorporation. We do not want to stop or discourage genuine commercial incorporations. We are proud of our record in encouraging the start-up and growth of small firms, not least with the stability that we have been able to bring to the general economy. The changes that we are making in the Bill build on that success. They reduce the unfair tax advantages that can distort competition between incorporated and unincorporated businesses, and they ensure that the incentives in the tax system that are designed to promote growth will do just that.

For that reason, I hope that the hon. Member for Fareham will not press amendment No. 43. Amendments Nos. 41 and 42 go directly against what businesses say to us that they want—a simple and fair tax system—so I hope that he will not press those amendments, either. If he does, I shall ask my hon. Friends to resist.

Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 10:15 pm, 25th June 2007

This has been a brief debate, which is probably to the advantage of all hon. Members; as the Financial Secretary said, we have rehearsed these arguments before.

I accept that amendments Nos. 41 and 42 are quite crude amendments. In a sense, they mirror what the Government have sought to do by increasing the small companies rate, because the Government's increase has been a very crude way of tackling a problem of their own making. Perhaps the Financial Secretary should take his own advice about measures that could end up distorting commercial decisions. Tax can distort commercial decisions, as the 2002 tax changes clearly did. He needs to reflect on that when considering future changes.

It is clear that, despite the package that the Financial Secretary described, as we established in the Committee of the whole House, the average gain for businesses from the introduction of the annual investment allowance is about £60 or £70 a business. The loss for small companies as a consequence of the increase in the tax rate is about £1,000 a company. I think that many small businesses and companies will find that a burden, and will find that they cannot invest as much as they would want to invest in developing their staff.

That sends out mixed and confused messages to companies that hear the Chancellor praising large companies and cutting their corporation tax, while small companies are penalised by this increase. That is why I wish to press amendment No. 43 to a vote—to send out a clear signal that at least on the Opposition Benches, we back small companies and want to see them grow.

Question put, That the amendment be made:—

The House divided: Ayes 191, Noes 268.

Division number 152 Orders of the Day — Clause 3 — Small companies' rates and fractions for financial year 2007

Aye: 191 MPs

No: 268 MPs

Ayes: A-Z by last name

Tellers

Nos: A-Z by last name

Tellers

Question accordingly negatived.

Further consideration adjourned.— [Mr. Watts.]

To be further considered tomorrow.