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TW Ed raises some questions about government policy and corporate tax.

Past Form: Roll Up, Roll Up

The interaction of the dividend tax regime with Corporation Tax has meant that there has been a strong tax-based incentive for individuals or smaller family-type companies (broadly, Owner-Managed Businesses) to incorporate. This has subsisted for well over a decade, and through various governments.  It was, for instance, a government of a very different colour to now, that unveiled the nil starting rate of Corporation Tax. I recall the surprise amongst tax advisers (and, I suspect, most of HMRC) at the time – it was too good to be true. And so it proved: the 0% rate itself was short-lived. But the general theme prevailed.

I think I was not alone in inferring that the government was very keen for businesses to incorporate. Maybe it was the brass band and the flashing neon signs. It could be said that advisers might have been criticised if they had not recommended it to many of their clients.

Change of Heart?

Fast-forward to July 2015 and the second of three Budgets:

“Mr Deputy Speaker, we’ve cut Corporation Tax from 28% to 20% over the last Parliament, one of the biggest boosts British business has ever seen.

We can’t take it lower than that while such strong incentives are created for people to self-incorporate and pay the lower rates of tax due on dividends.

The dividend tax system was designed partly to offset double taxation on profits.

But the system has not changed despite sharp reductions in corporation tax. Lower rates are creating rapidly growing opportunities for tax planning.”

From the perspective of OMB companies, this simply does not compute: starting rates aside, the “small companies” tax rate has hovered around 20% for almost 20 years. While there are many companies whose profits exceed £300,000, the vast majority of OMB companies will fall comfortably within the £300,000 profits limit below which 20% (or thereabouts) has prevailed for donkeys’. The reduction in the headline or “full” rate of Corporation Tax will not have made a scrap of difference to all but a very small percentage of UK companies. It will have been largely meaningless to those who might “self-incorporate”, since the reduction in the main rate will not have saved them a single penny. Prospective reductions in the now-aligned rates might, however.

“The reforms I’ve announced to dividend taxation also allow us to do something more – and go further in creating a Britain that is one of the most competitive economies in the world... Britain’s corporation tax rate will fall to 19% in 2017 and 18% by 2020.”

One might say this is fair enough: if everyone’s CT rates must fall, then dividend taxation should perhaps have to rise, to compensate. Page 72 of the Red Book indicates that the Chancellor’s measures to tighten up the dividend tax regime will net £8.6billion by 2020/21, Meanwhile, the reduction in CT rates will have cost the Treasury £6.6billion, leaving the government £2billion better off and, by implication, some UK taxpayers £2bn out of pocket. A simple comparison is perhaps unfair since, like so many Chancellors’ announcements, the pain is felt some time before the promised gain.  

Reasonably Certain of... Uncertainty

Apart from the government, who profits? Certainly not the vast majority of OMB companies.

A previous article analysed the impact of incorporating / running businesses under the new regime. One thing that has been reduced under the new regime is certainty: unless you can be reasonably sure of a consistent level of profits, then the net tax benefit or cost of “self-incorporation” is impossible to predict. Under the soon-to-be former regime, a net arithmetical benefit was largely guaranteed. From April 2016, the margin will be much narrower, and in some cases there will be a net cost to running a business through a company. Negating (or at least reducing) a benefit is one thing. Replacing it with uncertainty is another.

The Red Book also formally introduced us to a new set of initials: TMI, or “Tax-Motivated Incorporation”. And we see at page 73 that the government expects to save a further £2billion by 2020/21 from deterring further self-incorporation activity. I am not sure of the logic here, or what is being compared to what. I am not convinced that there remains £2billion to be saved, now, by incorporating. Would it not have been more straight forward simply to aggregate the forecast yield to HMT, from tweaking dividends, to be £10.6billion by 2020/21?  If you're cynically thinking that the government may have done this to hide the net cost to OMB companies of £4billion over the next few years, then you'd be wrong. I think it will be significantly worse than this for OMBs, since they will not be the main beneficiaries of the "balancing" reduction in Corporation Tax rates. (OK, rate). 

Who Benefits?

Having established that the vast majority of OMB companies in the UK will be significantly worse off as a result of the changes, who benefits, apart from the Treasury?

It would be unfair not to recognise that a very large number of individuals with modest shareholdings and relatively small amounts of dividend income will be delighted that their Lloyds, HBoS or RBS dividends will no longer be taxable. (Yes, I know). The £5,000 threshold beneath which dividend income will not be taxed is an excellent simplification and, like the rather less simple new “Savings Allowance”, will remove many people from having to deal with tax returns and the nuisance of paying piddling amounts of tax every year. (Actually, the potential saving is rather more than piddling but I am thinking of the relatively large number of ex-employees / de-mutualisation holders who may get only a few hundred quid at most, and I think likely to represent the largest class of beneficiaries).

But I suspect the “greater” beneficiaries, at least in proportion, are those relatively few companies that enjoy very substantial profits into the millions and that, having already benefitted hugely from the reduction in the main rate of Corporation Tax, will benefit further as the combined rates continue to fall. And, while dividend taxation has (or will very soon have) changed fundamentally, one thing that hasn’t changed is ITA 2007 s 811 etc., which effectively means that foreign shareholders in UK companies will continue to enjoy UK dividends without UK tax cost. For them, there is no uncertainty: reduced rates of UK Corporation Tax will simply mean greater profits from which to draw larger tax-free dividends.

More, this time from 2011:

“I want Britain to be the place international businesses go to, not the place they leave. Let it be heard clearly around the world - from Shanghai to Seattle, and from Stuttgart to Sao Paolo: Britain is open for Business.”

Would it be overly simplistic to conclude that such international largesse is soon to be funded by hundreds of thousands of UK family companies?  Likewise, will the CEOs of FTSE100 companies be having a whip-round to say “Thanks, awfully”? I am struggling to see the underlying rationale, or the benefit to the UK. It would be interesting to know if HM Treasury had figures on what it would have cost to introduce the new £5,000 dividend “Allowance” without also introducing the new dividend rates.

Pop Quiz

Finally, what do the following tax incentives have in common, apart from a surfeit of initials?

• R&D
• EIS / SEIS
• FYA CAs on EZs
• Patent Box
• Creative Industry Reliefs
• IAs
• CIs (aside from goodwill)

So, the government now apparently really dislikes Tax-Motivated Incorporations. But if that should be the case, then perhaps it should reflect on quite why it is, that so many of its flagship reliefs are available only to companies. I used to assume - naively, of course - that these were some of those gaudy neon signs that encouraged incorporation. I realise I was wrong. So what was the real reason?