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.