Clause 32 - Corporation tax starting rate and fraction for financial year 2002

Part of Finance Bill – in a Public Bill Committee at 3:15 pm on 16th May 2002.

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Photo of Edward Davey Edward Davey Shadow Chief Secretary to the Treasury, Shadow Minister (Olympics and London), Liberal Democrat Spokesperson (Olympics and London), Liberal Democrat Spokesperson (Chief Secretary to the Treasury) 3:15 pm, 16th May 2002

I did not participate in the previous debate on incorporation because my comments are particularly relevant to clause 32. Some of the comments made by the hon. Members for Arundel and South Downs and for Fareham apply in spades to this clause.

The Government propose to cut the starting rate of corporation rate from 10 per cent. to 0 per cent., thereby increasing significantly the existing incentive for sole traders and self-employed people to incorporate. It is a huge increase in that incentive. I want to develop the argument and speak about the potential cost of the tax revenue lost. Calculations by the Institute for Fiscal Studies, and indeed a report in yesterday's Financial Times, suggest that the costs may be much larger than those estimated in the Red Book, so the debate is particularly important.

I shall begin by clarifying what is going on. At the moment, people have to choose between being self-employed and paying income tax on their profits and national insurance contributions at a reduced rate, or incorporating to create a company of which they are the only shareholder and employee, in which case they pay tax as normal on their salary and pay out profits to themselves in the form of dividends on which they may or may not pay corporation tax. [Interruption.] For the record, we can hear some interesting noises but I think that we are safe.

The measure will significantly change the tax question of whether to be self-employed or to incorporate. To illustrate that point with an example, by setting up a company a person would be able to pay themselves a personal allowance of £4,615 against income tax, and on top of that make profits of up to £10,000, which would be paid out in dividends, while facing no tax liability. As a result of the clause, a person who incorporates could earn £15,000 and pay no tax. Labour Members may want to reflect on the distributional issues raised by the measure.

The cost of the measure is relevant because the Committee is concerned with protecting the taxpayer. The Government have estimated the cost of the measure and, as I said in my brief intervention in the previous debate, that has been aggregated with the measure on the small companies tax rate in the figures that I read out previously. It is not clear, although I am sure that the Paymaster General will clarify this for us, what the Government estimate the cost of the specific measure to be. Assuming for the sake of argument that the cost of the measure is the whole of the figure in the Red Book—which is a heroic assumption, but let us make it—by 2004-05 the Government estimate that the cost would be £450 million. I should be interested to know how they arrived at that figure, or a lower figure of which the Paymaster General is about to inform the Committee.

I should particularly like to understand the assumptions about the number of corporations that will benefit. Have the Government assumed that that will consist of the current number of corporations because there will be no behavioural changes as a result of the measure? Have they made an assumption about an extra tranche of self-employed sole traders who will decide to incorporate? Have they assessed that in arriving at their estimates? If they have, how many sole traders do they estimate will incorporate?

As the Committee scrutinises the Government's policy, it is important to see whether they have got those estimates right. I want to dwell on that point

because of the work done by the Institute for Fiscal Studies. Through its analysis of the survey of personal incomes 1998-99, it says that 1.2 million self-employed people each stand to gain in excess of £500.

Sitting suspended for a Division in the House.

On resuming—