EEF blog

At the Mansion House speech a couple of weeks ago the Chancellor of the Exchequer and the Governor of the Bank of England announced the government’s new Funding for Lending scheme.

As several surveys, including the Bank of England’s, the BBA's, and our own have shown, for many companies credit conditions remain constrained. The Funding for Lending scheme has therefore been designed to sustain and encourage new lending. This is an important goal. As the Chancellor himself pointed out:

“A lack of credit is damaging businesses and costing jobs”

Funding for Lending reflects a recognition that more needs to be done. On Tuesday, the Governor of the Bank of England expressed concern that some of the government’s previous attempts to increase access to credit may have been ineffective.

What is different about Funding for Lending?

Members of the MPC pointed to the aspects of the Funding for Lending scheme that should differentiate it from previous attempts to boost lending in the economy.

The Funding for Lending scheme is designed to take advantage of the record-low borrowing rate currently faced by the government and pass some of this on to business. The basic idea is that the scheme should mean UK banks can access to wholesale funding at rates below the natural market rate over several years.

Crucially, access to the scheme will be linked to the performance of the banks in sustaining or expanding their lending to businesses and individuals throughout the UK.

Will it work?

Mervyn King pointed out that the biggest challenge facing banking was the macro-economic challenge. The economy is in a precarious position, as the Eurozone crisis continues to weigh on confidence and demand. Lending to businesses has declined of late. While the aim of the Funding for Lending scheme will be to increase lending to business, conditions in the economy will inevitably affect whether this happens or not.

King said that he would be happy if the scheme expanded lending, but that for him the definition of success would be that lending was higher than it would otherwise have been were the scheme not in place. The fact that access to the scheme is linked to how much banks lend should provide a significant financial incentive to lend.

Full details of the scheme have yet to be released, and we will blog more on it then.

There's an article in the FT today 'Corporate tax regime taken to task' that supports many of EEF's previous assertions that the UK's current tax system of recognising the depreciation of plant and machinery investments does not match the demands of rebalancing the economy.

Perhaps more telling for the government, the article, which is quoting research from the Oxford University Centre for Business Taxation, suggests it is failing on its own stated ambition of making the UK the most competitive tax system in the G20.

'Britain ha[s] the highest effective marginal tax rate of all but two countries in the OECD group of many of the world's most advanced nations.'

This means that:

'Even after the implementation of the planned cuts to corporation tax, the UK will not be particularly competitive relative to other countreis in the G20 and OECD'

The driver for this is cited as the capital allowances regime in the UK - recently made even less supportive by the government:

'...allowances for capital spending in Britain...are lower than any OECD country except Chile.'

It's worth remembering that perhaps 50,000 businesses might benefit from the government's cuts to the headline rate of corporation tax but 900,000 are made worse off by less supportive capital allowances.

The Treasury in its response notes that the Chancellor recognises tax competitiveness is about more than corporation tax and points out reforms to the CFC regime, R&D tax credits, and the incoming Patent Box. It is encouraging that the Treasury has this wider view and indeed there has been good progress in the areas mentioned.

But I don't think the Treasury can afford to keep rowing in the wrong direction on capital allowances for too much longer. It is a bit rich to claim the Centre for Business Taxation is looking at an 'incomplete picture' when the effective rate is surely more inclusive than the Treasury's focus on the headline rate of corporation tax - important though the cuts to the headline rate are.

What we need now is a fundamental reevaluation of the UK's uncompetitive system of capital allowances.

I got out to another couple of companies last week to chat about tax. I'm working on the link between our tax system and investment - how we can improve policy to drive higher investment.

The first company, a pre-revenue R&D intensive firm mainly wanted to talk about finance. The state of finance for highly innovative companies in the UK isn’t what it needs to be to drive a rebalanced economy.

The main problem seems to be access to late-stage venture capital. This is a problem in a lot of countries, not just the UK – but the supply of this kind of finance, the patience of investors, and the willingness to take a risk were all seen as healthier on the other side of the Atlantic and possibly in Israel.

As far as tax went, this company was unsurprisingly a big supporter of R&D tax credits and praised the government’s extension to the generosity of the SME scheme. But they also thought the credits cut out far too early in the innovation process.

This company isn’t selling anything yet – but is working through all the process problems of manufacturing a proven concept at scale and at an economic cost. Clearly this is innovation – but the R&D tax credit is not available to support this process.

The other company I saw last week was a large multinational manufacturing in many countries around the world including the UK.

This company gave a reality check on how influential tax was in influencing company investment decisions.

While the government’s bold cuts to the headline rate of corporation tax were attention-grabbing for the company, they are still not powerful enough to overcome the factors driving where the company might put its next factory, which primarily related to where demand in the world is growing.

Where the corporate tax rate is relevant in developed markets is in influencing decisions about where the company retains capacity.

Another issue that I found illuminating was this company’s compliance issues. In my own naivety I had thought that tax compliance was a real issue for smaller companies that might have a finance director and nobody else to manage all tax and finance matters – but that a big company would not see this as anywhere near a problem to the same extent.

But what I was told last week was that compliance is a problem for big companies. Even a large multinational with a dedicated tax team will likely still use outside consultants for example to claim for R&D tax credits.

And keeping up with changes to the tax code is a constant challenge.

As far as solutions to this complexity went, one idea we discussed related to both R&D tax credits and capital allowances.

Rather than creating complex tax-specific regimes administered by the HMRC, why can’t we have R&D claims and capital allowances audited as per standard accounting practice?

In the case of capital allowances this could remove the need for the capital allowance regime altogether – replacing it with an expense on the P&L that reflects the economic reality for the plant and machinery in question.

Good ideas worth exploring further…

EEF’s recent Business trends survey shows manufacturers continue to have strong intentions to invest despite the uncertainty on the horizon.  The survey asks whether respondents are planning to increase or decrease investment over the next 12 month period. 

A positive balance of 15% of respondents (those indicating they plan to increase investment minus those planning to reduce investment) indicates that in general investment plans are on the up. 

Manufacturers came out of the recession with very strong investment intentions.  While this has fallen somewhat since the high reached in the first quarter of 2011, the balance remains well above the series average.   

 
Smaller firms are not as positive though…

The story below headline intentions shows that while businesses across the size spectrum have stronger investment intentions than the pre-crisis period 2004-2008, smaller firms are more constrained. 

There are a number of factors at play here, and member companies and other organisations seem to agree that smaller firms have greater difficulty in accessing finance. 

• Yesterday we spoke to a pre-revenue firm that is facing challenges to raise the finance they need.  In the UK, late-stage venture capital is very hard to come by. 
• A recent report into the new lending appeals process showed that 40% of appeals resulted in the banks original decision being overturned.
• The Bank of England’s Trends in Lending survey also points to some constraint on SMEs – growth in SME lending has been negative since 2009 and has been lower than the lending to all public non-financial corporations since March 2011.
• There are also likely to be some demand factors at play here – some small firms may not know about the range of finance options available and some may be choosing not to invest in the current uncertain economic environment.
  

The government is committed to building the most competitive tax system in the G20. But what does that mean? 

I'm doing a bit of thinking about tax policy at the moment and going around the country talking to members about their views to try to come up with some answers about what we think it means. In particular I'm interested in where people see tax policy as needing to be to help support investment in the UK.

Down in the South East on Wednesday I was asking members about various recent tax reforms, here's a feel for some of their thoughts:

Corporation tax (headline rate cut from 28% to 24% and coming down to 22% by 2014/15 to be lowest in G7, fourth lowest in G20)

A lot of people saw the corporate tax cut as 'free money' for large corporate shareholders that wouldn't be re-invested but simply paid out as dividends

Capital allowances (Annual Investment Allowance reduced to £25k from £100k; main write-down rate reduced from 20% to 18%)

Not surprisingly given our vocal commentary on this in the recent past members weren't that happy with these changes. But I thought the discussion on Wednesday helpfully focused in on the key issue for what was primarily an SME audience - cashflow

R&D tax credits (small company rate increased to 225%; large company scheme to be moved 'above the line' and made available to loss makers)

Good support for the R&D tax credit - not as a driver of investment in its own right but as an important incentive to go further.

Again the link was made with investment i.e. credits > improve cashflow > lift investment

A bit of niggle about how difficult the credit is to claim for with consultants creaming off 25% of the value gained.

Tax compliance

General feeling that the government had a way to go on this and that the crack down on anti-avoidance was hitting soft targets rather than the real tax dodgers.

This week the Index of Production showed that manufacturing output fell by 0.7% between March and April. The monthly figures can be quite volatile, but this follows on from the first quarter of the year, in which growth in manufacturing was flat.

However, the headline manufacturing figures mask a considerable degree of sectoral divergence. For example, in the first quarter of the year the consumer-facing food and drink sector contracted by 2.5%, but the export-focused motor vehicles sector grew by 3.1%.

Our recent Business Trends survey also reflected this divergence between sectors. Those sectors which are consumer-facing, or exposed to big swings in commodity prices, are facing significant headwinds. These include electronics, food & drink, and chemicals & pharmaceuticals.

Further out in 2012 assuming inflation starts to soften as expected, and the consumer recovery begins to gain momentum, these sectors should begin to see the benefit of this. However, the ongoing crisis in the Eurozone continues to dampen confidence for the time being.

The affects of the Eurozone crisis on Business Confidence have also impacted to outlook for global investment. Mechanical engineering has been one of the stronger sectors in the recovery, but the weaker investment outlook means that – while we still expect growth – this is likely to be at a slower pace than in 2011.

The strongest performing manufacturing sectors have been those with high levels of exposure to growing emerging markets, such as motor vehicles and other transport (which includes civil aviation), which have benefited from strong demand.

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