EEF blog

Out at another couple of companies this week talking about tax. These were large companies, one in specialty chemicals, one in aerospace.

First thing that comes through loud and clear is that if we think big cuts to the headline rate of corporate tax are going to radically ramp up investment from big manufacturers we need to think again.

Other business drivers such as being close to markets, following OEM customers, and the supply of skilled labour were seen as much more important to determining where investments are being made. Highlights the importance of coordinated action across multiple areas to support growth.

However, tax IS an important secondary consideration.

One company told me the signalling effect of cutting the headline rate shouldn't be underestimated. It gives company's a sense that the government is moving in the right direction. The more confidence companies have this direction will be maintained the stronger this impact will be rather than the precise change per se.

Another company said that tax is an important 'tie-breaker' when locations are similar in terms of other characteristics e.g. some of our European competitors.

But we also discussed the importance of other parts of the tax system.

Sourcing is also influenced by tax. The scrapping of industrial building allowances (finally ending last fiscal year 11/12) meant one company wouldn't build anymore factories here - it would lease them instead - is that what the government wants?

Another company was fired up about the R&D tax credits and Patent Box. The credit compared favourably with other countries, notably the U.S., and is widely known amongst the large corporates. The Patent Box was also seen as a positive...though would it encourage the development of more patented technology in the UK was less clear.

Tax compliance and administration is an age old tax complaint. The mentality of the tax authorities was noted as being unhelpful - assumption seems to be that default position for companies was to avoid tax. Many attempts to curb avoidance were catch-all and created cost for companies that are compliant without catching the real tax avoiders.

HMRC's large company service with its 'customer relationship managers' was seen as positive; all the quality of CRMs is seen as variable and the benefit needs to be kept in perspective - if the tax legislation is still horrendously complex, the CRM can't do much.

Last Friday I commented on the FT article noting Oxford University research on how the UK’s corporate tax environment is not as competitive as it might seem following cuts to the headline rate of tax.

This research provides yet more evidence that the government needs to look beyond the headline rate to achieve its aim of creating ‘the most competitive corporate tax regime in the G20’.

In particular the UK’s poor capital allowances regime is uncompetitive.

Capital allowances are the tax system’s way of handling depreciation – a major issue in capital-intensive sectors like manufacturing.

For small companies, capital allowances are essential. Capital allowances support cash flow – which empirical evidence suggests strongly correlates with investment particularly for liquidity-constrained firms, including SMEs with fewer finance options than larger firms.

For large companies, FDs or tax directors often have their personal performance partly assessed on the effective average tax rate (EATR) they achieve for their company. EATRs will of course be the result of multiple taxes companies face.

The Oxford research shows that the corporate EATR in the UK overall in January 2012 placed the UK 22 out of 33 OECD countries.

With the government's programme of further cuts to the headline rate, we are on course to 'rocket' up to 16th by 2015 - but that assumes no other country in the OECD changes their policies beyond what has already been announced.

While 16th would be an improvement it’s not quite fitting with the spirit of the government’s ambition. It seems to me the government needs to go a bit further.

We believe the obvious target is the capital allowances regime.

Look at what’s happening elsewhere in the world.

On 1 June, the U.S.-based National Association of Manufacturers, along with a long list of major manufacturing companies, wrote to both houses of Congress saying they should:

‘…provide an immediate and temporary incentive for businesses to make new capital investments in the United States by extending 100 percent expensing…through 2012.
Enacting this legislation will enable businesses to access capital for immediate investment and create jobs in the United States now…

…Currently, however, businesses can only elect to deduct 50 percent of the cost of these investments.’

This is a scheme that was in place in the U.S. until the end of 2011. There are strong suggestions the boost in orders for manufacturing technology seen last year were the result of this intervention.

Canadian Manufacturers and Exporters continue to say:

‘Companies that can write-off older, inefficient equipment faster, have greater incentive and opportunity to invest in newer, more efficient technology. CME is advocating for making the two year write off on manufacturing and processing equipment permanent.’

The Canadians are saying the current two-year write down on manufacturing and processing equipment should be permanent. NAM goes further in the U.S. given the economic situation and talks about 50 percent deductions (two-year write downs on a straight-line basis) as not being enough.

Under these regimes write-downs take TWO years. And just to be clear, American and Canadian manufacturers are saying this is not fast enough.

Under the UK’s current system, investments in plant and machinery take more than THIRTY years to write down.

Spot the competitiveness problem.

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…

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.

Today in the news there's been a lot of talk about BDO's new report Manufacturing the Future, which, amongst other things notes that only 25% of the manufacturing companies surveyed think the government is adopting the right strategies to support and develop UK manufacturing.

That might be puzzling to some in the government who with some justification might point to the current rate of corporation tax, now just 24% and scheduled to fall further to 22% by 2014/15.

But if ever there was devil in the detail then this is surely an example. What we hear a lot from our members is how (at least for the initial changes) the government paid for this cut to corporation tax by reducing the Annual Investment Allowance and the main write-down allowance for capital allowances.

Respectively these have been reduced to £25,000 (from £100,000) and 18% (from 20%) with effect from April 2012.

The big concern with this is the impact it has on SMEs cashflow. These firms are not beneficiaries of the cuts to the headline rate of corporation tax and they often have fewer sources of external finance than larger companies - cashflow is an essential driver of their investment.

If this doesn't make much sense, consider the following example for how capital allowances work and why for some companies current government policy might not be seen as particularly supportive:

 Now compare this example with what was in place prior to April this year:

One of the ambitions the government has set out in its little-known ‘Plan for Growth’ is to create the most competitive tax system in the G20. This is a laudable aim.

And though the government does emphasise its bold cuts to the headline corporate rate as being the centrepiece of meeting this ambition, we now from references in other tax consultations (e.g. on the R&D tax credit) that the government recognises there is more to competitive tax policy than cutting one tax.

This year, we are going through a process of refreshing our tax policy positions after a successful 2011 campaigning year (we pushed for the lengthening of the short-life asset definition for capital allowances to eight years and for the R&D tax credit to be payable ‘above-the-line’).

When thinking about the UK corporate tax environment, we’ve found it useful to think about the tax system in terms of how it confronts different groups of companies.

At the moment we're dividing companies up as follows:

• Start-ups;
• Fast-growing SMEs;
• Mid-sized businesses looking to go public; and
• Multinationals.

These companies face similar growth challenges related to their point in the growth cycle and likely also have similar issues with the tax system – whether that means the tax system is creating an undue burden for them or not supporting them sufficiently.

So I just thought I might list out some of the issues we think are important to creating the most competitive tax system in the G20 from the perspective of these different groups to signal the sorts of issues we’ll be looking into over the year.

Start-ups

• Tax incentives for investors to provide start-ups with finance, like the new Seed Enterprise Investment Scheme
• The relevance of incentives to encourage corporate investors to invest in small companies, like the discounted corporate venturing scheme.

Fast-growing SMEs

• The administrative difficulties companies have coping with VAT requirements and NICs/PAYE.
• Allowing more companies to account for their corporate tax liability on a cash basis, as the government has just started for businesses with annual turnover up to £77,000.

Mid-sized businesses looking to go public

• Capital allowances and how they encourage investment.
• The challenges larger mid-sized businesses have complying with the government’s controlled foreign company regime.

Multinationals

• The definitions of expenditure used for the R&D tax credit
• How companies can make best use of the government’s new ‘patent box’.

These are the sorts of issues we think need to be addressed in the UK if we are truly going to have the most competitive tax system in the G20. As our tax work progresses we'll be sharpening up our recommendations for the government on tax if it's going to meet its Plan for Growth ambition.

This week we’ve been blogging about the how the Chancellor could set out a stronger, clearer strategy for growth at this year’s Budget.

So far we have set out three bold ambitions for 2015, and associated measures of progress, that we think would form the core of this stronger vision:

• More companies bringing new products and services to market;
• More globally-focused companies choosing to expand in the UK;
• A more productive, more flexible labour force.

The final ambition we have is to have a lower cost of doing business in the UK.

High regulation, energy, and tax costs discourage job creation in the UK. These costs also have a deadweight effect, creating a high baseline cost of servicing human resources and compliance processes which detract from the productive capacity of business.

Lowering the cost of doing business in the UK will help existing firms to succeed in international markets and attract new ones to locate here.

The government already does have some ideas in this space for example with its one-in, one-out policy on regulation or its commitment to have the lowest corporate tax rate in the G7.

But UK businesses need to see the government commit to going further.

A firmer commitment is needed to cut the burden of regulation. Merely stemming the flow of cost in regulations is not enough. We want to see a reduction of 10% in the time and money spent complying with domestic regulation.

We also need to address the long-term deterioration in the competiveness of the UK’s electricity prices. It’s fine to want to develop the green economy but why does it have to be at the expense of UK industry? Since 2006 the UK’s largest industrial consumers have paid 19% more than the EU average.

The Chancellor needs to make good on his call to not extend ourselves further than our European competitors, we want to see him go slightly better and commit to having industrial electricity prices below the EU average.

Our competitors are also constantly seeking to improve the competitiveness of their tax systems, we need an ongoing effort to hit what will continue to be a moving target.

As mentioned above this is an area where the government is making some good progress on headline corporate tax rates. But creating yhe most competitive tax system in the G20 must be on a range of measures well beyond the headline rate of corporation tax.

It needs to include areas like support the tax system gives for R&D or capital investment and how our system taxes jobs too.

These three key areas – regulation, electricity prices, and tax – form the basis of our ambition to have a demonstrably lower cost of doing business in the UK in 2015 compared with 2010.

Together with the other three ambitions and associated measures, this forms EEF’s proposal for a clearer, stronger strategy for growth. We hope the Chancellor responds with vigour in his Budget speech on Wednesday.

JJ Churchill is a high-precision engineering SME business in the aerospace, powergen, defence and high-horsepower diesel engine sectors.  Products include the development and production of advanced gas-turbine blades and complex diesel engines assemblies.

During the last recession JJ Churchill decided that it was imperative to continue to re-invest. This stood us in good stead at a time when many of our competitors were freezing investment decisions. These investments have meant that we achieved profitable growth of 25% in 2011 and we are now looking ahead to the next step in our 7-year business plan, that of overseas expansion.

Setting up a manufacturing facility in a foreign country is a daunting step for any business, especially an SME. But our customers – such as Rolls Royce and Siemens – expect their first-tier suppliers to offer them a local service in Europe the Americas and Asia.

The company’s need to grow, alongside this pressure to regionalise, meant we needed to enter the market for high volume gas-turbine blades (rather than just the development and spares market). Without the move into the high volume market, our strategic plan to become a £50m business by 2019 risked stalling.

But here’s the ‘rub’. When it comes to the manufacture of high volume gas-turbine blades there are two principle costs: the cost of constantly re-investing in advanced capital equipment; and the cost of skilled labour.

JJ Churchill has been able to use technology to balance the cost of labour and drive consumer value in the relatively competitively un-constrained developments and spares market. But this model breaks down when it comes to high volume gas-turbine production. The UK has the ideal skills present for this work, but the UK's investment environment is not competitive.

Advanced machine tools now cost ten-fold what they did 15 years a go. At the same time their competitive life (not to be confused with their productive life) has come down from around 10 to five years.

The UK government’s approach to capital allowances has simply failed to stay synchronised with manufacturing reality. At the same time other economies have gone out of their way to attract inward manufacturing investment.

Without a much more attractive investment environment, high technology, high-value added manufacturing will not be sourced in the UK.

JJ Churchill’s decision to expand overseas is exciting and will ultimately secure our growth plan and consequently jobs in the UK. The UK will remain the source of our approach towards gas-turbine blade manufacturing process innovation and spares supply. So in one sense our move to manufacture overseas is no loss to the UK and therefore ‘invisible’ to the government.

But the pity is that if the rhetoric of ‘re-balancing the UK economy towards manufacturing’ (oft heard from both the previous and current governments) had more substance – including a full overhaul of the tax treatment of capital to better reflect the life-span of modern machinery – then this ‘invisible’ story of overseas investment could very easily have been a good news story for the UK.

George Osborne has made a major improvement to the UK’s tax environment for R&D today by announcing in his Autumn Statement that the R&D tax credit will become payable ‘above the line’ from 2013/14.

This reform will increase investment from companies already the UK as well as bring additional investment in R&D to the UK.

The change means that rather than large firms accounting for the R&D tax credit in their tax return ‘below the line’, the benefit will be accounted for upfront in R&D budgeting ‘above the line’.

The key benefits of moving to an above the line credit are:

• Creating a simpler system;
• Strengthening the link between the R&D tax credit incentive and the parts of companies where investment decisions on R&D are made;
• Increasing certainty around the timing of the benefit of the R&D credit by decoupling it from a company’s tax profile.

Innovation is crucial for keeping ahead of the competition, generating better balanced growth, and creating high-value jobs.

When the R&D tax credit system was introduced it was a positive development for the UK. But our competitors do not stand still. Many countries have sought to incentivise greater expenditure on innovation and attract mobile R&D investments by introducing reforms to their own schemes to increase the incentive effect.

Today Mr Osborne has responded. He has made clear that the ambition he stated in March, to make the UK ‘the most competitive tax environment in the G20’ means the whole tax system, not just the headline rate. This is welcome news because it corresponds to how companies see the impact of taxes.

PwC has conservatively estimated this reform would deliver £665 million per annum of additional value to the economy at a net cost to the Exchequer of £205 million per annum. These are meaningful numbers at a time when the UK must be doing all it can to support growth.