Two’s Company—U.K. Corporate Tax Rates to Begin with a “2” for First Time Since 2016

We now have a “spend and tax” government—a quite different approach to the “tax and spend” governments of the past. The U.K. chancellor Rishi Sunak has been trying to answer the question of who pays for 407 billion pounds ($568 billion) of coronavirus spending, and when. The answer is everyone, but not just now.

The chancellor acknowledged that he hopes economic growth will go some way to improve the position, with tax collected rising as the economy recovers. However, this in itself will not be enough to pay for the 407 billion pounds spent on Covid-19 so far.

Abandoned Plans

The chancellor has abandoned the decade-long plan of reducing the headline tax rate of corporation tax. The tax rate on large companies will rise to 25% from 2023. The original logic was that a low tax rate would encourage investment, investment creates jobs, and jobs result in the real drivers of tax— Pay As You Earn (PAYE) income tax and National Insurance Contributions (NICs). Wages in turn get spent and drive value-added tax (VAT) receipts.

Large Companies

Why the focus on large companies? According to HM Revenue & Customs (HMRC), the majority of corporation tax (CT) liabilities comes from a relatively small number of companies. In 2018–19, approximately 4,500 companies had liabilities over 1 million pounds, yet these contributed 55%, or 30.2 billion pounds, of the CT liability total. In contrast, just over 1 million companies had liabilities of less than 10,000 pounds and these contributed just 6%, or 3.4 billion pounds, of the CT liability total. It obviously makes sense to focus on the big payers not the smaller ones.

It’s interesting that the definition of “small” companies—those with profits of less than 50,000 pounds—is relatively low, and businesses with profits greater than 250,000 pounds will be taxed at the full 25% rate. This is pushing the impact of higher tax rates further down the company structure than many had expected.

Further Benefits for the Treasury

There’s a knock-on effect as well. Controlled foreign companies legislation means that large companies with overseas activities in lower tax jurisdictions, defined as 75% of the U.K. rate, may find that more of those overseas profits could be brought within the charge to U.K. taxes. Expect to see U.K. headquartered companies looking closely at their holding structures.

What Does Abandoning the Low Tax Rate Mean?

The headline rate doesn’t really matter that much. Yield is what really matters. It is driven by the granting and withdrawal of reliefs from that headline rate. More reliefs are a tax giveaway, fewer reliefs are stealth taxes. According to the Organization for Economic Co-operation and Development, in 2018 the U.K. received only 8% of its tax revenues from corporation tax at a rate of 19%. Germany and France, with headline rates of 33% and 30%, raised only 4.6% and 5.6% of their tax revenues from companies. The headline rate means little—though we know multinational CEOs check it before embarking on big investment projects, so it primarily acts as a signal to business about how the government views the place of companies in the economy.

Increased Reliefs

The increased reliefs available for investment, the 130% super deduction for investment in new equipment from Budget Day, should go some way to driving down the effective rate in the short term. For many companies the challenge will be having sufficient access to finance to fund the investment in the first place.

The ability to carry back losses to earlier periods to receive repayments of tax will reduce the effective rate of tax and improve cash flow—but both will have little impact on the post-2023 landscape. This extension will apply to trading losses made by companies in accounting periods ending between April 1, 2020 and March 31, 2022 which can now be carried back for up to three years, subject to an overall maximum of 2 million pounds for each period after April 1, 2020. Companies that can take advantage of this should look to complete their accounts and tax computations at the earliest opportunity and make a tax repayment claim.

In contrast, the small and medium-sized enterprise research and development tax credit is now capped in any one year at 20,000 pounds (plus three times the company’s total PAYE and NICs liability). There seem to be some mixed signals here.

As illustrated above, what the chancellor gives, he can also take away, so don’t be surprised to see these reliefs reduced as tax rates go up. However, given the struggles of many companies at the moment there is little to be gained by taxing the loss making activities today.

Time to Reappraise Some Projects?

We must remember, corporation tax is a tax on investment returns and investments tend to be long term—so companies will need to re-evaluate the projects they have at hand and determine whether the after-tax rate of return post 2023 is still acceptable. If it isn’t, the project needs to be reconfigured, abandoned or reviewed. Delaying the rise until 2023 gives company management and investors plenty of time to consider their investment plans, understand the likely taxes payable and consider their response.

The creation of new English Freeports that will be based in East Midlands Airport, Felixstowe and Harwich, Humber, Liverpool City Region, Plymouth, Solent, Thames and Teesside, and will be special economic zones with different rules designed to make it easier and cheaper to do business, is quite a departure for the U.K. The challenge will be ensuring this does not simply move existing activity from outside the Freeport to within it, but rather attracts and encourages genuinely new investment and jobs. It appears that investment will be encouraged by allowing for enhanced tax deductions for certain types of expenditure within the Freeports.

Complexity not Simplification

Despite the efforts of the Office of Tax Simplification, having a lower tax rate for small companies, a higher one for large companies, and a taper rate for those in between, creates more complexity in the tax system. When combined with the requirements for many companies to make payments on account before the final tax liability is known—finance directors may be having to wrap a cold towel around their heads to understand what needs to be paid, where and when.

More to Come?

The bad news is that this is not the end. On March 23 the chancellor is holding a “tax day” where he will set out his plans for the tax system over the next few years. We can be pretty sure that more proposals for a potential reform of the U.K. tax system will be buried in there. Corporate management should take a long-term view—don’t just fall for today’s headlines about the budget but wait and see what comes out of tax day—that will give the real flavor of how companies are to be taxed in the future.

The economist Samuel Brittan said “Only individuals pay tax, companies are just a convenient place to collect it.” Any increase in tax for companies will actually impact customers, employees and investors. That’s why the reversal of the tax reduction policy needed to be carefully calibrated. Superficially, it is good politics to tax those without a vote—companies have no vote—only lobbying power. The impact of that tax will be felt more broadly throughout the economy, and that’s why the chancellor has decided to tread carefully today.

Realism and Honesty

Increasing personal allowances and then freezing them, deferring an increase in tax on large companies until 2023 but allowing enhanced loss carry backs and super deductions for investment in innovation now, all suggests the chancellor recognizes that there is little point in taxing a struggling economy today.

But if the economy can start growing quickly in the next year or so, there will be more income and more profits to tax in later years. The political judgment is that the impact of the increases won’t be felt too much in the run up to the next general election.

The word “honesty” was used repeatedly. This may be because by not increasing the headline rates of VAT, income tax and National Insurance, but finding other ways of raising cash, often delayed until the future—the classic way of raising stealth taxes—the chancellor wants to avoid accusations of being too stealthy.

This was a budget designed to defer the pain, but also lay the groundwork for future tax-raising activities. Companies were always a logical target and they will adapt—but management will need to keep a careful eye on new developments and proposals between now and 2023, as it feels like this was just the beginning.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Laurence Field is a Partner, Corporate Tax, with Crowe in London.

The author may be contacted at: laurence.field@crowe.co.uk