Expressing tax reliefs as a cost to the state – as HMRC regularly does – is an unhelpful way to refer to vital business allowances that will boost growth, argues Stephen Herring. The tax guru and former IoD head of taxation makes the case for the main concessions and explains how the system could be improved
It may seem obvious to business leaders that taxes need to be simple, enforceable and set at a level that will fund essential public spending without slowing the economy, yet these fundamentals have eluded governments of all stripes. The first of the three objectives, simplicity, is perhaps the most fiendish to achieve. In an increasingly complex and globalised economy, designing a system that stimulates entrepreneurialism, innovation and GDP growth while also being understandable is a task that has befuddled ministers for decades.
Every January HMRC publishes a spreadsheet of figures entitled “Estimated costs of principal tax reliefs” (gov.uk/government/statistics). This seems to suggest that all income earned by individuals and businesses is owed to the state, which then decides how much to let them keep. Very few IoD members will agree with this idea.
While the government may view tax concessions merely as red figures in the Treasury’s books, we can see how valuable they are to enterprise by looking at them individually. Here are the seven largest reliefs by HMRC’s estimate of their “cost” to the state last year, along with an assessment of their ripeness for reform.
Capital allowances (excluding annual investment allowances) – £18.975bn
These form by far the largest tax concession for business. But, to set this sum in context, the equivalent total for the income tax personal allowance is estimated at £101.3bn.
Capital allowances apply to spending on machinery and other items. They replace accounting depreciation, which is not tax-deductible, with a fixed rate of allowance on expenditure that boosts a company’s productive capacity. It is important to remember that firms’ spending on new machinery comes out of their profits. Without this relief, the government could end up taxing a business on more than what it actually makes at the end of the year.
Double taxation relief – £3.2bn
This concession protects the income that a company gains from abroad. The UK has bilateral agreements with more than 100 countries to help prevent businesses from having the same income taxed by two jurisdictions. This is a long-standing and widely accepted measure that promotes trade and investment across borders. To abolish double taxation relief would oppose this aim and breach many of the country’s international agreements.
Research and development tax credits – £3.01bn
These were created to support ventures doing innovative work in science and/or technology. Broadly speaking, the expenditure must be part of a specific project seeking advances in one or both of these fields. The idea of helping companies to develop emerging technologies that would improve UK plc’s productivity has widespread political backing, so it’s highly unlikely that any chancellor would remove this arrangement.
Entrepreneurs’ relief – £2.7bn
This enables entrepreneurs to reduce their capital gains tax liability – substantially in some cases – when they sell all or part of their business. Some critics argue that this exemption doesn’t directly motivate anyone to start a venture, because it applies when a business is sold, rather than when it’s founded. But this misses the fact that many entrepreneurs, including serial investors, use the proceeds from the sale of a business to finance the next one.
Annual investment allowances – £2.52bn
Aimed predominantly at mid-sized firms, these provide 100 per cent relief on the first £200,000 of capital expenditure. Given the concern across the political spectrum about what Andy Haldane, the Bank of England’s chief economist, calls our “long tail of low-productivity firms”, this vital relief should really be increased.
Business property relief from inheritance tax – £710m
If this were to be abolished, the death of a company owner would lead to a tax charge of 40 per cent when the beneficiaries inherit the deceased’s shares (or business assets). More often than not, this would need to be met from the firm’s post-tax profits or the proceeds of its disposal. Generally, the market for the disposal of a minority stake at a fair price to the vendor is very limited at best. Ending this relief would have far-reaching and undesirable effects on business continuity.
Agricultural property relief from inheritance tax – £515m
The fact that relatively few people in the UK own agricultural land makes this concession a tempting target for abolition. But, aside from the justification for business property relief above, it is worth considering that agriculture generates low returns relative to the assets it requires. If the government were to end this relief, many farmers would no longer be able to settle their inheritance tax liabilities without selling land, which would break up holdings and further dent the profitability of British farming.
Is simplification possible?
While all of these allowances – and others, such as the enterprise investment scheme (a snip at £420m) – provide clear benefits, they are sometimes criticised for their part in making the system complex. But it is possible to simplify things without losing any growth-boosting reliefs.
Income tax rates could be reduced by, for instance, using the savings that would be achieved by removing the upper threshold for national insurance contributions or restricting the relief on pension contributions to the basic rate (20 per cent) of income tax.
When it comes to capital allowances, the writing-down allowance rate could be cut from 18 per cent to 15 per cent, which would enable the government to increase the annual investment allowances to £1m – a boost for mid-sized firms. This is the kind of positive simplicity that the government should focus on, rather than eliminating beneficial concessions because it has mislabelled them on those annual HMRC spreadsheets as “expenditures”.
We hope that the chancellor will protect these crucial reliefs in the November budget – and indeed be bolder by seeking to increase and liberalise tax concessions that would ultimately make the economy more competitive.
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