He doesn’t understand, does he?

Thirdly, Ed Balls is looking at an “allowance for corporate equity” as part of reforms to encourage more long-term attitudes in business. I admit that this one does cause me concern. There can be no doubt that the UK’s very generous tax relief for interest paid by companies has been significantly abused. We have seen takeovers of football clubs, like Manchester United, funded almost entirely by debt which has been loaded onto the companies themselves, with the result that massive tax subsidies have been given to the buyers. The same is true of mainstream companies. Indeed, this is the whole allegation about tax avoidance at Boots. What worries me about the approach that Ed Balls is looking at is that instead of tackling this abuse it seeks to give an equivalent tax allowance to those companies that fund their activities using shareholder money instead of borrowings.

I have three problems with this approach. Firstly, it does not tackle the problem of excessive debt funding or the tax relief given upon it. Secondly, it simply creates another corporate tax giveaway, and big business has enjoyed a whole raft of these over recent years meaning that this is the one sector of the economy as a whole that has enjoyed tax cuts. Thirdly, this is another arrangement that favours big business over small enterprise. No small company has significant shareholder funds so this relief is going to leave them almost unaffected whereas large companies do, however much their debt, tend to have a significant value of shareholder funds. That means they’re bound to get this tax relief, so upsetting the balance between small and large business yet again, with the bias being, once more, against small business.

Tax relief on interest is not a tax subsidy. It’s simply a determination of who is legally responsible for paying the tax.

Corporate profits are taxed at the level of the company with (in effect) and extra rate applying to higher rate taxpayers who receive dividends.

Interest is not taxed at the company level: it is taxed when it reaches the recipients. Who is legally responsible for the payment of that tax doesn’t particularly matter. It’s still being taxed. The so called “relief” is simply a determination of who, legally, has to pay said tax.

As to what Balls is suggesting: that looks like a desire to tax economic profits rather than accounting ones. An “allowance for shareholder funds” would mean that, or at least could mean in one formulation, that you measure the normal rate of return to capital (aka “the cost of capital”) and ignore that for tax purposes. Only companies making in excess of this, making those economic profits, would be charged tax on only the portion of profits that is above that normal rate of return.

This is, of course, a thoroughly good idea and is one of the recommendations of the Mirrlees Review.

7 comments on “He doesn’t understand, does he?

  1. Yes, but your argument also only works if all borrowing is done arms-length from lenders in the same tax jurisdiction. A loan from BartSucks financial services LLP (Caymans) (trading in association with BartSucks toffee bars UK Ltd.) at a slightly inflated rate with the interest neatly eating up what would have been that year’s profits is neither.

    It’s – because forriners – we have direct taxes on business profits rather than just taking dividend income. So finding a creative way of getting around that is something the governments are going to go after, whether you like it or not.

  2. What is actually going on at the moment is that funds are being held in UK treasury companies and then loaned to group members in higher tax jurisdictions. Giving an “allowance for shareholder funds” would accelerate this quite a bit, meaning thickly (that doesn’t sound right!) capitalised UK companies – which get an allowance and which lend to fellow group companies at as high an interest rate as you can get away with. Double bonus.

    However, wouldn’t it all be much less complicated simply to reduce or abolish CT?

  3. BiG>

    Lending is done at arms-length, or at least on arms-length terms. If the rate is significantly higher than the market rate, it won’t be allowable, and if it’s not significant, who the hell cares?

    In any case, we don’t want to tax foreign investment capital unless our intention is to harm poor people.

  4. “No small company has significant shareholder funds…”

    Erm, that doesn’t sound right. Small companies rely more on shareholders, usually the founders themselves, because they can’t get loans. Slightly bigger companies can get loans but the rates aren’t great; and they can’t issue bonds. So any tax change that favours shareholders over bondholders will (generally) benefit smaller companies more than large ones.

  5. Ed Balls doesn’t know what he is talking about? But he went to Oxford and did PPE and then he worked at the Financial Times! Oh , I see what you mean.

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