Small company ouch!

  • Robert Peston
  • 23 Mar 07, 10:36 AM

Prompted by some miffed small companies, I’ve made a few simple calculations on the impact of the Budget on the tax they pay. And I can see why some young and growing businesses are expressing their views of Gordon Brown in unprintable language.

Here are three examples. If you are a company that makes a profit of £250,000 per annum but invests next to nothing in general plant and machinery, then you will be £7,500 a year worse off as a result of the increase in the small company tax rate from 19% to 22%.

So far, so painful.

However, if you are the kind of business that invests in new plant and machinery every year, then you’ll benefit from the introduction of a £50,000 annual investment allowance available to all businesses regardless of size and regardless of their legal form. This allowance will mean that 100% of investment in equipment up to a ceiling of £50,000 can be offset against taxable profits.

So if you happen to invest £50,000 per annum, you should end up paying about £1,000 less in tax, as a result of the combination of the new investment allowance and the increase in the tax rate.

But vast numbers of small businesses invest nothing like that amount every year. So let’s assume you invest £25,000 per annum in such kit – which seems to me to be a more realistic figure – than you would be around £3,000 a year worse off following the Budget changes.

To be unfair to the Treasury for a moment, I am ignoring the increase in the enhanced deduction element of the small company Research and Development tax credit from 150% to 175%, because many businesses complain that they find it impossible to claim.

So what do I think about all of this?

Well I can understand the Treasury’s concern about individuals gaming the tax system and incorporating simply to reduce their personal tax and national insurance liability. So there is some logic to the tax hike, as a deterrent against incorporation by individuals who aren’t really running proper businesses.

But genuine discomfort will be caused to perfectly legitimate businesses – which seems an odd thing to do, given the years of rhetoric from Brown that small companies are the lifeblood of a growing economy.

Finally, I am uncomfortable about the Treasury’s attempt to compensate companies by effectively bribing them to invest through enhanced tax breaks on investment. If it does lead to incremental investment, much of that new kit will be unnecessary, white-elephant stuff, the equivalent of gold taps.

Ideally, investment should only be made following a hard-nosed assessment of whether the discounted cash-flow returns likely to be generated by the investment exceed the cost of capital. And a sensibly designed tax system shouldn’t distort that assessment.

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