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

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

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Photo of Mark Hoban Mark Hoban Shadow Minister (Treasury) 10:00 pm, 25th June 2007

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.