A budget for Growth?

March 22, 2011

Thomas Story_NSP8121By Thomas Story, Tax Director, BDO LLP. The opinions expressed are his own.

George Osborne has promised that measures to boost sustainable growth will be central to this week’s Budget. To meet this objective, the Chancellor faces the challenge of accelerating the reform of business taxation within the severe constraints imposed by the overall fiscal position and the political imperatives of the coalition government.

Many previous reforming Chancellors have benefited from a more benign fiscal outlook to facilitate fundamental fiscal reform (Nigel Lawson and Gordon Brown spring to mind). The daunting fiscal deficit means that any tax reforms must be achieved within a tax neutral framework; Geoffrey Howe’s Budgets in the early 1980s are a closer precedent but the need to accommodate both parties to the coalition agreement provides additional dilemmas in 2011.

The emergency budget in June 2010 set out the road map for corporate tax reform which outlined a vision of a more competitive tax framework with the aim of making the UK the location of choice for international business. This set out underlying principles including a commitment to a simpler taxation system with lower headline rates but acknowledged that these must be achieved for the present without any overall reduction to the levels of corporate tax receipts. In practice, this can only be achieved by restricting targeted tax reliefs.

The main rate of corporation tax is already scheduled to be cut from 28 percent to 24 percent over four years, which will be partly funded by reductions in capital allowances on plant and machinery. To maintain this momentum, the Chancellor must be tempted to go further, perhaps by announcing a target corporation tax rate of 20 percent or less. This may be achievable if there is a substantial improvement in levels of corporate profitability provided, of course, that the growth targeted by the Chancellor can, indeed, be sustained over the next four years.

To date, the other main thrust of corporate tax reforms have been to simplify and restrict the scope of rules addressing Controlled Foreign Companies (‘CFC’s) and overseas branch profits. The common themes of these reforms is to promote the UK as a location for international groups by introducing a more territorial basis of taxation and ensuring that anti-avoidance rules apply only where profits are artificially diverted from the UK.

It is understandable that the emergency budget focused on these areas given the pressing need to enhance the attractiveness of the UK as a location for large international groups. Further details of these reforms can be expected in this budget. The Chancellor must tread carefully to fulfill these objectives while taking account of the growing public intolerance for wholly artificial tax planning.

Furthermore, it is essential that this budget drives this reform agenda forward to encompass the wider business sphere including all entrepreneurial businesses/SMEs. Authentic simplification of the excessively cumbersome corporation tax code should be an urgent priority but the corresponding need to restrict or eliminate overly targeted tax reliefs will require a degree of political courage.

Perhaps the single most significant step to boost both business growth and employment would be to cancel, or even reverse, the planned rise in employers’ national insurance by 1 percent to 13.8 percent from next month.  This is viewed by some as a tax on jobs. However, the challenge of finding the necessary replacement tax revenues without alienating an electorate facing stagnant levels of income and rising living costs cannot be underestimated.

We may see a commitment in the budget to simplify, or even merge the existing income tax and national insurance systems. This would be fraught with both technical difficulties and political challenges. In principle, few could argue with a more transparent system of personal and payroll taxes but there are clear political dangers in a system that spells out more clearly the overall tax suffered by voters on their income.

Nevertheless, if George Osborne does hold ambitions to be remembered as a truly reforming Chancellor, it is possible that he could seek to refashion the framework of rates and allowances to achieve the coalition’s pledge to remove the first £10,000 of employment income from taxation altogether and also reduce the marginal tax burden for employers to recruit new staff.

On Wednesday, the Chancellor will set out his proposals to address these challenges. The political and economic stakes are high but, inevitably, the verdict will not be clear until, and perhaps beyond, the next general election.

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