Sunday, October 26, 2008

Tax breaks for small business - an off the wall idea?

As we enter a period of recession expect to hear calls for more 'tax breaks' and promises of these from politicians on all sides. 'Tax break' is a more accurate term than the alternative of 'tax incentive' which has previously been used despite the inbuilt inaccuracy of the term. The truth is that so called 'incentives' are simply rewards for spending money in ways that the Government wishes to encourage.

Wikipedia's current definition of 'tax break', whilst US in style, seems quite clear to me:

A tax break is a tax saving. This includes:

  • Tax exemption, an exemption from all or certain taxes of a state or nation in which part of the taxes that would normally be collected from an individual or an organization are instead foregone.
  • Tax deduction, an expense incurred by a taxpayer that is subtracted from gross income and results in a lower overall taxable income,
  • Tax credit, more valuable than an equivalent tax deduction because a tax credit reduces tax dollar-for-dollar, while a deduction only removes a percentage of the tax that is owed.
Then reason I prefer this term to 'tax incentive' is that the latter is a complete misnomer when it comes to decisions made by most owners of micro and small businesses - who are often the main target of the so-called 'incentive'. The problem being that the targets are rarely aware of the incentives and even if they do hear about them they either don't qualify or can't afford to invest the money required to benefit from the 'incentive'.

A couple of examples will suffice:
  • Research and development tax credits - these don't so much incentivise investment in R&D as reward those who have spent the money - some time after the money has been spent; If your expenditure qualifies your subsequent tax bill will be reduced or you will receive a tax refund - at such time as you would otherwise have paid your corporation tax;
  • Annual Investment Allowance - again, not so much an incentive to acquire qualifying plant and machinery expenditure as a reward. Actually this is a very welcome simplification. The 100% relief removes the need for anyone to worry too much about the distinction between such capital expenditure and other business expenditure.
The problem with tax incentives and tax breaks is that so many people seem to misunderstand what's really going on. In business terms neither tax breaks or tax incentives actually impact decisions, other than at the margins. A pro-active accountant will, for example, encourage a client to advance expenditure plans into the current tax year so as to secure the tax benefits a year earlier than would otherwise be the case. But either the business has access to the funds or they don't.

The promise of tax relief at least 9 months (often more) down the line, by way of a tax break or a tax incentive is NOT going to have a significant impact on business owners' motivation. And, more than anything else it isn't going to provide the funds to facilitate the expenditure that is supposed to have been encouraged.

The only way I can see to do this is to effectively subsidise the cost of the items in question so that the purchaser only plays, say 70% of the normal price. The vendor then recovering the remaining 30% of the price from HMRC. This is not a million miles away from the way that the GiftAid system works for charities. We give them a donation and they recover a related sum (of tax) from HMRC.

Would this work? Is it worth considering further?

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