§ Question proposed, That the clause stand part of the Bill.
10.15 pm§ The Economic Secretary to the Treasury (Mr. Peter Lilley)Since 1979 we have introduced a large number of 118 measures to help small businesses. The Finance Bill introduces further measures. In particular, clause 26 reduces the rate of corporation tax on the profits of small companies from 27 to 25 per cent. Since we have been in office, the small companies rate of corporation tax has been cut by 17 percentage points from 42 to 25 per cent.
This is the sixth successive year in which we have been able to keep the rate of tax to the small company in line with the basic rate of income tax. It is now the marginal tax rate for the vast majority of unincorporated businesses. Out of a total of 418 companies paying corporation tax in 1985–86, the last year for which we have comprehensive figures, no fewer than 392,000 companies paid tax at the small companies rate. A further 19,000 were in the transitional band, still paying below the full corporation tax rate. Only about 7,000 companies in the United Kingdom paid the full standard rate of corporation tax.
The total number of companies in the low tax band has been increasing rapidly. Between 1982 and 1985–86 an additional 160,000 companies paid the small companies rate. The number of companies rising into the transitional and full tax zones has more than doubled, so more companies are paying more tax, but at lower rates. Above all, this reflects the return to profitability of British industry as well as an increase in the number of small businesses that have been started or expanded.
As a result of the progressive reduction in the small companies tax rate and related changes, the regime for small businesses in this country is now one of the most favourable in the industrialised world. We have a lower rate of corporation tax than most countries, we have a more favourable rate for small companies than most countries, and we have a wider band to which that rate applies than almost any other country. In short, Britain is now as attractive a country in which to establish and expand a small company as any of our major competitors and there is every incentive for our small companies to grow larger. The clause reinforces that position, and I am pleased to put it before the Committee.
§ Mr. Chris SmithIt might help if I said at the outset that we do not intend to divide on clause 26. We welcome its provisions, but there are a number of questions about it that ought to be answered.
First and foremost, the clause enshrines the principle of progressivity. The Labour party has advocated and will continue to advocate a much more progressive income tax system. The same principle ought, in fairness and logic, to be applied to corporation tax. That principle is enshrined in the proposal that there should be a 25 per cent. rate for companies whose profits do not exceed £100,000 and also in the consequential adjustment to the marginal relief fraction.
We also welcome the clause because we support and wish to encourage the growth and development of small businesses. The Chief Secretary told us in the Budget debate that the Government are doing far more for small businesses than have any previous Government. He told us that the number of small businesses is increasing at about 500 a week. That figure is more or less accurate. The number is 494 a week—a figure that is based on VAT-registered companies and VAT returns. It is worth pointing out that the equivalent increase for the the period 1974–79 was 417 a week. The Government have made a marginal improvement in the rate at which small 119 businesses have been established, but the record of previous Labour Governments stands reasonable comparison.
The Government have taken a number of measures that doubtless they will claim encouraged the formation of small businesses, including provisions for a delay in the payment of tax by giving an average of several months' credit to small businesses. Those small businesses would probably nominate liability on the preceding year basis, which allows the offsetting of costs and expenses against tax. The Government would probably also claim to have helped small businesses through the self-employment schemes and national insurance changes. It is small wonder, therefore, that small businesses may have improved their position marginally over the lifetime of the Government.
The greatest factor affecting small businesses is the level of interest rates. In that regard, the Government do not have such a good record. To the detriment of small businesses and, indeed, business as a whole, we still have one of the highest real rates of interest of the entire developed world. That is not something of which the Government should be proud, even if it is a matter by which the Prime Minister seems to place so much store when considering the exchange rate level and the Government's inflation policy.
A further caveat should be entered. If we are placing so much importance on the development of small businesses, we should pay attention—the Government never seem to pay attention to this—to the increasing domination of our economy by large business and large-scale enterprise. The figures are startling. If we look at the number of firms in the United Kingdom representing the upper half of retail sales, we find that in 1950 there were 4,750. By 1961, the figure had fallen to 1,700. By 1971, it had fallen further to 930. According to 1985 figures, the figure now is 94. The concentration and centralisation of economic power which that represents is something about which the Government should be more concerned. It is fine to talk about promotion being available for small businesses but at the same time a blind eye is being turned to the agglomeration of an enormous amount of economic power into the hands of a small number of companies.
The further change in the corporation tax rate for small businesses may encourage payments to be made to shareholder-directors in the form of dividends rather than a salary. If a privately owned small company makes a profit and distributes it as dividend to basic rate tax paying shareholders, it pays corporation tax at 25 per cent., against which the shareholder's personal income tax can be set.
That results in a tax burden of 25 per cent. to the company and zero per cent. to the shareholders, giving a net tax rate of 25 per cent. If, however, the same profit is paid as salary to the directors, who, in small companies, are also likely to be the shareholders, the company has to pay 10.45 per cent. in national insurance and the employees have to pay 9 per cent. national insurance on top of their basic rate tax. The net tax burden in such circumstances is therefore 41 per cent. I think that we are entitled to ask whether it is right that we have a system which, because of how national insurance operates, encourages that device.
120 Broadly speaking, we favour the clause. We shall not divide the Committee but simply want the Government to be a little more honest and realistic about small businesses and the desire—theirs and ours—to encourage the enterprise that they represent. Moreover, the Government should cover the efforts of small businesses and the Opposition's attitude with less of a gloss than they sometimes apply.
§ Mr. Graham Bright (Luton, South)I, too, sincerely welcome clause 26. Any reduction in the tax payable by small companies is desirable, to say the least, but I am worried lest we leave it there.
Small companies usually try to expand. They often borrow heavily and are not flush with cash. It is irksome to make a profit and then have to pay out quite a lot of it in taxation. A company may be keen to expand or re-equip, especially in view of present challenges, such as preparing for 1992. It is important that our small firms are as well equipped and prepared for 1992 as are those in Germany or France. Moreover, they must face competition from engineering companies in South Korea and Taiwan.
When companies want to retain cash for further development or research and development—I am not talking about those which milk profits to pay directors or use schemes such as the hon. Member for Islington, South and Finsbury (Mr. Smith) described—we should make it as easy as possible for them to put their profits back to work. That is always more difficult for small companies. They cannot be as fast on their feet as a large company with a chain of accountants looking for every possible way in which to delay or avoid paying taxes.
We are talking here of corporation tax for small companies being in line with income tax. That is great, and I hope that we will keep it that way. It prevents any temptation to switch funds or to take them out of the company. There is a problem with the existing structure. I have argued for a graduated corporation tax. At the moment there is a marginal rate between £100,000 and £500,000. The effective rate for companies of this size is 37.5 per cent., which is 2.5 per cent. over the higher rate. I always think that that is a bit of a discouragement. It causes a company to think seriously about putting the brakes on at £100,000 and perhaps using all sorts of devious ways to stop paying that tax. I want to see a system that alleviates that.
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I do not want a system under which companies waste money. That always worries me. Sometimes an accountant says to a company, "You are going to make a profit, so it might be a good idea if you got rid of some money. Perhaps you ought to buy yourself a new Merc, refurbish the office or buy some equipment." Such spending does not occur because a company wants it to, but because it is a way of getting rid of some of the money. I do not like that, and I hope that we will look at that point. Let us make sure that we do not put things in the path of small businesses so that as they grow they design their business round the tax system. That is wrong. The tax sytem should be there to take money when people are making profits, but we should make it simpler. When we talk about a progressive tax, I hope that that is what we mean and that we will not have the clawback position that we have now.
121 We have put corporation tax in line with personal income tax, so what about providing an allowance for tiny companies? For personal income tax there is an allowance of £2,605. For a large company that does not mean anything. However, for small companies, we should have a band of profits that are tax-free at the lower end. It could be linked to the personal allowance, but it could be higher, at perhaps £5,000 or £10,000. I am suggesting that because we should try to encourage companies to put cash back into the business. We should encourage small businesses to do that regularly.
As I said earlier, we are looking towards 1992 and we want to make sure that companies are equipped to face the position then. The most important thing they can do to equip themselves is to ensure that they have the most modern tools and machinery and that they invest money in research and development. Often a company starts well and gets its own share of the market, but if it does not plough money back into research and development, it loses that share of the market.
I welcome the clause and I congratulate my hon. Friend the Minister on what he has introduced. However, I hope that he will look at the points that I have raised because they bother me as a small business man, and I know that they bother most of the small business men to whom I have spoken.
§ Mr. BeithThe hon. Member for Luton, South (Mr. Bright) made some interesting suggestions. This is not the moment to go into the list of things that small businesses would like to see modified to make their lot easier. However, I should like to place on record the fact that we welcome the reduction in small business corporation tax.
We suggested to the Chancellor that he might use the corporation tax device that was so successfully used by the right hon. and learned Member for Surrey, East (Sir G. Howe) when he was Chancellor, which was to carry out a phased reduction in corporation tax for large as well as small companies. That produced an incentive to 122 investment, which might have been a productive step to take in current circumstances. There are quite strong arguments for doing so. The present Chancellor has not done that, but he has at least given the corporation tax reductions for small businesses in this clause and we welcome them.
§ Mr. LilleyI do not intend to detain the Committee, but I should like to respond to a point raised by my hon. Friend the Member for Luton, South (Mr. Bright) to whom I pay tribute as a doughty defender of small businesses. He raised the question whether there should be a tax-free band for small businesses. There is a problem in that that would create a more favourable position for incorporated business than for unincorporated businesses. Also, it would presumably have to be available for all companies large and small, or we would have the problem of clawing it back, which would create a somewhat higher rate while it was being clawed back. My hon. Friend said that that happens under the present system, when we move from the rate for small companies to the standard rate. The clawback rate in that intermediate zone is significantly below the low rate that we used to have for small companies. Therefore, the position is not too serious and companies generally feel better off than they did.
I am grateful to the hon. Member for Islington, South and Finsbury (Mr. Smith) for the fact that he does not propose to divide the Committee. I welcome the Committee's support for the cause of small businesses. I confess that I am slightly puzzled that the Labour party thinks that business men should pay a lower rate of tax than the ordinary man in the street, but that is for it to explain to the electorate.
§ Question put and agreed to.
§ Clause 26 ordered to stand part of the Bill.
§ To report progress and ask leave to sit again.—[Mr. Peter Lloyd.]
§ Committee report progress; to sit again tomorrow.