Corporation tax cuts may not be good news for all business investment

24 June 2010

As promised, the Chancellor used the emergency Budget to introduce phased reductions in the rate of corporation tax.

Starting from 1 April 2011, the headline rate of corporation tax is to be reduced by 1 per cent each year for four years until it reaches 24 per cent.

There was good news for smaller companies too. The small companies corporation tax rate is also to be reduced next year, down 1 per cent to 20 per cent.

The cut in the headline rate will leave Britain offering the lowest rate of profit tax ever, as well as the best in the G7 and the fifth lowest in the G20 economies.

However, the price is going to be a reduction in the rates for capital allowances. For most plant and machinery assets, the rate of allowance is to decline from 20 per cent to 18 per cent. For assets with a longer lifespan, the special rate is to drop from 10 per cent to 8 per cent.

The Annual Investment Allowance is also to fall. The AIA enables most businesses to cut their taxable profits by the full amount of their annual capital investment on most plant and machinery up to £100,000 a year. That figure will come down to £25,000.

To give businesses a chance to adapt to the reductions, the Chancellor said that the allowance cuts would not take effect until April 2012.

The move received a broad welcome from the business community, but there were voices of concern.

The cuts to capital allowances should raise some £1.8 billion in lost revenues and will simplify the complex tax break regime. Not all firms will benefit, though.

Jeegar Kakkad, an economist at the manufacturing employers’ group, the EEF, said: “Reducing the corporation tax rate over time was, in principle, the right course of action.

But financing it, in part, by cuts to investment allowances will be a heavy price to pay, especially for smaller companies. It might be a positive signal for large companies, but not for their suppliers.”

The Office for Budget Responsibility (OBR) in its judgment on the change insisted, nevertheless, that “the measures to reform corporation tax, which are estimated to reduce the cost of capital faced by firms by about 3 per cent, should have a positive effect on investment”.

But the OBR also issued a warning. The bank levy may see lenders impose higher borrowing rates as they attempt to pass on the cost of the new tax. In which case, some firms may find that the fall in the cost of capital is bounced in part by an increase in lending charges.