Chancellor of the Exchequer Gordon Brown surprised many yesterday by announcing
a 2% reduction in the rate of corporation tax and a 2% cut in the basic rate
of income tax, representing the first major cut in these taxes in many years.
Brown has been on the receiving end of growing criticism of his handling of
the public finances and his propensity to add complexity to an already unwieldy
tax system, but many of the more cynical observers believe that the Chancellor's
generosity has more to do with securing his place as the next Prime Minster
than it does with giving the UK's tax competitiveness a much-needed fillip.
Taking centre-stage in what is likely to be Brown's last budget speech was
the announcement that corporation tax would be cut by 2% to 28%. According to
the Chancellor, this would bring the UK's corporate tax rate below both the
OECD and EU15 average. However, tax experts observe that while the Chancellor
has given with one hand, he will claw back much of this lost revenue with the
other through changes in capital allowances.
According to the Treasury, the reform of the capital allowance regime will
"better reflect true economic depreciation," by ensuring that business
investment decisions reflect commercial rather than tax considerations. But
for manufacturers and companies with large property portfolios, the changes
could well cancel out any benefit brought by the cut in corporate tax.
"The reduction in corporate tax rate is essentially being funded by the
reduction in capital allowances," observed David Woodward, head of capital
allowances at KPMG. “Many businesses especially those in the more capital
intensive sectors such as hotel, leisure, retail and others with large property
portfolios are potentially going to be worse off."
“For example, retailers currently benefit from 25% allowance in the first
year on around 70% of their new store expenditure. From 2008 this will drop
to 20% and if the new rate for 'integral fixtures' is brought in this will reduce
further to 10%," he explained. “In addition, although the number
of rates has been reduced - which on the surface is a simplification - this
is at the cost of corporate taxpayers. Many of the areas of complexity still
remain. The Chancellor has missed a clear opportunity to simplify the capital
allowances system further.”
Paul Davies, UK Head of Tax at Ernst & Young noted that while the Chancellor
appears to have finally woken up to the pleas of the business community for
a tax cut, the overall result of the budget is a "mixed bag of changes
that may affect different taxpayers in different ways."
“The cut in the main rate of Corporation Tax is welcome, showing that
the UK is once again on a competitive path. This will reassure those companies
thinking of moving offshore. However, the gain from the rate reduction will
be more than clawed back by the change in plant and machinery capital allowances.
As a result it is clear that the main beneficiaries of the rate cut will be
in the service sector rather than the manufacturing sector," he stated.
While Adam Bainbridge, Head of Corporate Tax at KPMG, agrees that the 2007
budget "does absolutely nothing to help UK manufacturers or attract more
of them to the UK," he said that banks, creative or research intensive
businesses should benefit from the latest changes to the tax system.
But in a somewhat confusing message for the small business community, Brown
has also decided to increase the rate of corporate tax for small companies with
profits up to GBP300,000 per year by 3% to 22% over the next two years in a
bid to ensure "fairness across the tax system." This will entail a
1% increase from April 2007, another 1% hike in April 2008 and a final 1% increase
in April 2009. This move is being seen by the Treasury as part of tackling "tax
motivated incorporation" and an initiative towards "refocusing incentives
for small businesses towards those businesses that reinvest," but tax experts
argue that the move sends conflicting signals about government policy in this
area.
“This is a budget to confuse small businesses," said Tom McGinness,
head of middle market tax at KPMG. "On one hand it rewards them with increased
incentives on capital allowances and research and development. On the other
it penalises them by increasing the rate at which they pay corporation tax.”
“Despite promises to reduce complexity and administration costs, the
proposed changes to income tax and National Insurance will increase the burden
on SMEs and act as a disincentive to growing their workforce," he noted.
“The only certainty for SMEs is that the Chancellor’s changes will
make them less competitive and give them too little too late.”
More positive measures affecting business announced in the budget include:
the introduction of an Annual Investment Allowance of GBP50,000 which will target
investment support on all businesses that are investing for growth helping to
alleviate the cash flow constraints which confront small and growing businesses;
and an increase in the headline rate of the R&D tax credit rate for SMEs
to 175% from 150%, and increasing the R&D tax credit rate from 125% to 130%,
from April 2008.
Brown's decision to cut the basic rate of personal income tax by 2% to 20%
was also unforeseen by most observers, and his announcement that personal allowances
would be increased and tax brackets nudged upwards over the next two years has
been generally welcomed. However, as with the corporate tax cut, the revenue
blow to the Treasury will be softened by offsetting measures, such as the elimination
of the 10% tax band in 2008, and the alignment of National Insurance bands and
higher rate tax bands, thus meaning that higher earners are more exposed to
higher rates of national insurance contributions on more of their income.
“For personal taxpayers it is a similar story: abolishing the 10% band
in 2008 will actually raise more money for the Chancellor, which will be given
back by the reduction of the basic rate from 22% to 20%," added E&Y's
Davies.
“It is also worth noting that the changes in personal taxation are not
due to commence until April 2008, by which time the Chancellor presumably hopes
to be in Number Ten, with a view to an imminent General Election," he concluded.
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