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Finance (No. 2) Bill

Clause 26 essentially introduces schedule 14. Together, the effect is to replace the starting rate of corporation tax and the non-corporate distribution rate with a single small companies rate, which is currently set at 19 per cent. There are three important aspects of the background to the provisions, which the Committee may wish to consider in deciding whether the clause should stand part of the Bill. First, there are the reasons why the Government introduced the starting rate of corporation tax. Secondly, we had a wide-ranging debate with business and its representatives about the proper form of taxation for small businesses. Thirdly, responses were made to our announcement last December in the pre-Budget report that, as a result of those discussions, we had decided to remove the non-corporate distribution rate and starting rates of corporation tax. The Government have consistently supported business and enterprise. We have provided a tax regime with incentives for individuals to invest not just for their own future, but for the wider prosperity of Britain. We have also provided incentives to encourage business to expand and grow. We introduced the starting rate of corporation tax at 10 per cent. in the year 2000 and then reduced it to 0 per cent. in 2002 in order to provide the means for small companies to reinvest their profits in their business. As the Committee knows, we always keep the tax system and its operation under close review. We did so in respect of this particular matter, as we undertook to do when we introduced the measure. We saw that the benefits of incorporation and being able to access the starting rate were being used by some small businesses not as a step to growth, but simply as a vehicle to reduce their tax and national insurance contributions liability, while continuing to trade in exactly the same way as before, drawing profits in the form of dividends and not reinvesting them in the business. We therefore introduced the non-corporate distribution rate in 2004 to ensure that the benefits of the starting rate remained focused on companies that were retaining their profits for growth. We said at the time that the problem of tax-motivated incorporation was part of a wider issue and that the NCDR was not the end of the matter, but that we would consider the long-term strategic issues raised by these developments, to ensure that the tax system adequately reflects the realities of today’s changing labour market and business environment. In the pre-Budget report in 2004 we published a discussion paper and invited views from, among others, smaller firms and their advisers on these wider issues. The responses ranged almost as widely as the organisations. One thing is clear; there is no single fix that will level the field between all small businesses, irrespective of legal form. Although there was no consensus about the specific changes that they wanted, one overriding feature of the responses from all quarters was a strong preference for simplicity over approaches that risked introducing further complexity. Responding directly to the debate and to our own analysis of the situation, we announced in the pre-Budget report in 2005 that we would replace the starting rate and the non-corporate distribution rate with a single small companies rate. That is what clause 26 achieves. We wanted to refocus the way that we provide incentives for small firms that invest and grow. We announced that the first year capital allowances for small businesses would be increased for the year beginning April 2006 to 50 per cent., and that the turnover threshold for the VAT annual accounting scheme would be increased to £1.35 million; doubled, in effect. We also announced that we would look to increase the threshold for the VAT cash accounting scheme to a similar threshold, pending state aids clearance from the European Commission. Rather than favouring the incorporated small business, these measures will assist the incorporated as well as the unincorporated small business. About 4.2 million businesses are eligible to benefit from the increase in first-year allowances, 1.08 million small businesses are eligible to benefit from the increased threshold of the VAT annual accounting scheme, and about 733,000 businesses are eligible to benefit from the increase in the threshold for the VAT cash accounting scheme, if we can put it in place pending state aids clearance. That move in December was welcomed by business. In response to the pre-Budget report, the Federation of Small Businesses commented:"““The replacement of the zero rate of corporation tax by increased capital allowances for small business was welcome. This will reduce differences in the taxation of small business, depending on how they are organised””;" precisely the aim of the move. Furthermore, there is a clear ongoing desire and commitment on the part of businesses and their representative organisations to continue to work with us on the longer-term future of taxation for small business. In the Budget in March we therefore stated that we continue to believe that all individuals and businesses must pay their fair share of national insurance contributions and tax, irrespective of legal form. We also said that we would continue to review the tax and NI systems to ensure that that was the case, and that we would produce proposals for discussion consistent with a set of principles that include simplicity for compliant businesses, support for businesses in their aspirations to grow, and maintaining the attractiveness of the UK as a business location. These are the principles that underpin the provisions in clause 26. I commend the clause and the principles to the House.