4 Promoting Enterprise
Earlier chapters have discussed the measures the Government is taking to promote economic stability and employment growth. Building on those foundations this chapter describes further reforms designed to help improve UK business performance.
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Introduction
4.01 The UK has some of the most dynamic and enterprising businesses in the world. Unfortunately there are too few of them; too many firms lag behind the standards set by these top businesses and behind the performance of their international competitors.
4.02 Improving the performance of British business has to be the responsibility of the management, employees, and shareholders in individual companies. The DTI paper "UK Competitiveness: A Benchmark for Business" sets out the challenge by comparing the performance of UK businesses against our key competitors in each sector. The UK performs well in many respects. Some sectors such as pharmaceuticals are world leaders. But too often the average performance falls behind. Unless improvements are made there must be a question-mark over the long term viability of underperforming businesses and the jobs they provide in an increasingly competitive world economy.
4.03 The UK also needs to create - and sustain - more dynamic and innovative firms which can exploit technology, be at the forefront of design, and generate highly-skilled jobs which are the key to long-term prosperity. The UK has the raw material: a high quality science and engineering base, a record of creativity and invention, and the proven record of many world class entrepreneurs. However, it does not produce such businesses in sufficient numbers or on a sufficient scale, and not enough grow to be global companies.
4.04 The Government cannot itself improve the performance of industry or create dynamic new companies. But, in partnership with business, it can create the right framework for enterprise and investment. The Government is committed to removing the barriers that hold back investment and that discourage enterprising individuals from starting dynamic businesses that would allow British products and services to lead the world in the 21st Century.
4.05 The Pre-Budget Report (PBR) identified the main barriers to business growth in the UK. Principal among these are a record of economic and fiscal instability and a tax system that has distorted investment decisions and discouraged enterprise.
4.06 Earlier chapters have set out how the Government has tackled the issues of economic and fiscal stability. But to compete effectively in the global economy the UK must also tackle its legacy of chronic under investment.
Under investment
4.07 Since at least 1960 the UK has consistently invested less as a share of GDP than the OECD as a whole. The UK share has averaged around 18 per cent, compared to the OECD average of almost 21 per cent. The UK has also invested out of a lower level of GDP per head, this translates into a lower level of investment per worker.
4.08 As a result of lower investment per worker, the UK has a lower level of capital stock per worker as Chart 4.1 shows. This helps to explain why the UK's productivity is up to 40 per cent lower than our major competitors, and hence the lower level of GDP per head. If it is to improve its relative position the UK needs to invest more than other countries as a proportion of GDP, whilst ensuring that the quality of that investment is maintained and improved.
4.09 The PBR set out some of the Government's proposals for tackling these problems. Since the publication of the PBR the Government has been consulting widely on these proposals. The Government has listened to views of the business community, and the measures outlined in this Budget reflect that consultation.
A Corporate Tax System to Promote Quality Investment
Corporate Investment
4.10 This Budget continues the process of tax reform to produce a corporate and capital tax system that:
- does not distort corporate investment;
- promotes enterprise and rewards risk-taking;
- is fair and simple to apply.
4.11 The Government inherited a corporation tax system which did not encourage investment because:
- payments of tax credits on dividends were a distortion that encouraged companies to pay out dividends rather than reinvest their profits;
- advance corporation tax (ACT) led to surplus ACT for some companies, because they paid more ACT than they could set against their mainstream corporation tax bills. Surplus ACT often resulted in the double taxation of profits earned overseas when they were distributed by UK companies, and it hindered companies wanting to return excess capital to their shareholders. This distorted business decisions and led to inefficient investment.
4.12 The Government's first Budget:
- solved the first problem by abolishing payable tax credits;
- cut corporation tax rates by 2 per cent.
Advance Corporation Tax
4.13 This Budget confirms the Government's intention to deal with the second problem, by:
- abolishing ACT from 6 April 1999, which will eliminate surplus ACT for the future and reduce the complexity of the current system;
- preserving substantially companies' current expectations for using past surplus ACT after 6 April 1999
Quarterly payments of corporation tax
4.14 ACT will be replaced by a system of quarterly instalments for corporation tax paid by large companies:
- instalments will be phased in over four years, beginning with accounting periods ending on or after 1 July 1999;
- once the transition is completed, large companies will pay all their corporation tax by instalments, with 50 per cent due in-year (beginning in month seven) and the rest subsequently;
- interest rates on corporation tax underpaid and overpaid by large companies will be brought closer into line with commercial rates.
Main rate of corporation tax
4.15 The main rate of corporation tax will be cut by 1 per cent to 30 per cent from 1 April 1999 to ease further the transition to instalments.
4.16 The scheme under which companies have to account quarterly for income tax on gilt interest they receive gross will be abolished from 1 April 1999.
4.17 This package of measures will remove many of the distortions that discouraged investment. There will be a transitional cash flow impact on companies. However, taking these measures together, companies will gain by around £1.6 billion a year once these changes are complete.
Promoting Investment by Small and Medium Sized Enterprises (SMEs)
4.18 The Government recognises the importance of SMEs to a successful enterprise economy. Of the 3.7 million businesses in the UK, 99 per cent have under 50 employees. These firms provide 46 per cent of non-government jobs and, excluding financial services, 42 per cent of UK turnover.
4.19 To promote investment by SMEs this Budget:
Capital allowances
- extends enhanced allowances given to small and medium-sized business investment in machinery or plant. For expenditure in the year from 1 July 1998 the allowance will be set at a new rate of 40 per cent. This will assist cashflow and encourage SMEs to invest and modernise. The Government will review the operation of capital allowances in time for the next Budget;
Small companies corporation tax
- cuts the small companies' rate of corporation tax to 20 per cent from 1 April 1999, which will boost the after tax profits of both small and medium-sized companies and encourage them to invest;
Medium sized companies exemption
- exempts medium sized companies, alongside small companies, from quarterly payments of corporation tax to improve their cashflow;
- abolishes ACT which will improve the cashflow and reduce the compliance burden on small and medium-sized companies that pay dividends.
4.20 The Government will continue to look at how best to create an environment that encourages investment by small and medium sized enterprises. This will include reviewing the case for continuing with enhanced first year capital allowances.
Encouraging dynamic and innovative SMEs
4.21 Dynamic and innovative SMEs have the potential to make a vital contribution to employment and output growth. The evidence of the United States suggests that, increasingly, it is from small, often high-tech, start-ups that tomorrow's corporate giants grow. Yet in the United Kingdom such companies often fail to live up to their early potential. A business environment that encourages the growth of these companies is essential if the UK is to produce the high value-added products needed to compete internationally and generate the skilled employment opportunities which can sustain and improve the UK people's standard of living in a global economy.
4.22 To grow, dynamic and innovative SMEs need:
- entrepreneurs who have the energy and drive to grow a company;
- access to finance to develop good ideas into products. Many firms require significant start-up capital and development time to bring an innovative product to market. Financing these ventures is often perceived to be risky and investors need to be prepared to invest over longer periods to realise a return.
4.23 The Budget sets out a package of measures which improves incentives for entrepreneurs and investors.
Encouraging and rewarding entrepreneurs
4.24 To get the best out of the country's entrepreneurs the UK tax system needs to recognise the investment of individuals who nurture promising start-ups into successful businesses.
4.25 Reflecting this the Budget announces significant reform of Capital Gains Tax (CGT), which applies to capital gains made by individuals and trusts. The Government's objectives are to:
- encourage long term investment;
- reward risk taking and promote enterprise;
- introduce greater fairness for CGT payers.
4.26 Under the current capital gains system, tax is paid on the excess of an asset's sale proceeds over its acquisition costs, less a reduction to allow for any gain due to inflation. The system does not differentiate structurally between short-term speculative assets and longer-term holdings, or between business investment and investment in other assets. The indexation allowance also makes the system difficult to understand and complicated to administer.
4.27 The Government believes the capital taxation system should better reward long term investment particularly in economically productive business assets. The Government also wants capital taxation to be fairer and simpler to understand.
Capital Gains Tax
4.28 To achieve this the Budget introduces a CGT taper which for higher rate taxpayers will tax capital gains on business assets held for more than ten years at an effective rate of 10 per cent.
4.29 The taper will:
- for business assets, reduce the percentage of the gain chargeable from 100per cent (for assets held for less than one year) to 25 per cent (for assets held for ten years or more) - so under the new scheme the rate of tax for a higher rate taxpayer will fall from 40 per cent in the first year to effectively 10 per cent after the tenth year;
- for non-business assets, reduce the percentage of the gain chargeable from 100 per cent (for assets held for less than three years) to 60 per cent (for assets held for ten years or more) - so under the new scheme the rate of tax for a higher rate taxpayer will fall from 40 per cent in the first year to effectively 24 per cent after the tenth year.
CGT indexation allowance
4.30 The taper will replace the CGT indexation allowance on gains realised after 6 April 1998. Indexation will be frozen from 6 April 1998. Only holding periods after 5 April 1998 will count for the purposes of the taper, but, to ease the transition, there will be a one year addition for assets held at Budget day. So, for example, an asset bought on 1 January 1998 and sold on 1 July 2000 would be treated as if it had been held for three years (two complete years after January 1998 plus one additional year).
4.31 Chart 4.2 below sets out the reduction in the percentage of gain chargeable for business and non-business assets over a ten year period under the proposed reforms.
4.32 The Government is committed to building a fair tax system. Chapter 5 outlines further reforms to CGT designed to ensure capital gains are taxed in a fair and consistent manner.
Company capital taxation
4.33 The Government has announced a further period for comment on the taxation of capital gains realised by companies, in the light of the package now proposed for the personal sector.
Further measures to promote venture capital
4.34 The Budget proposes further measures to stimulate the provision of equity capital for smaller, higher risk, trading companies.
4.35 The existing Enterprise Investment Scheme (EIS) is designed to promote investment in such companies. The scheme gives relief from income tax at 20 per cent and deferral of a capital gain on up to £100,000 each year. CGT reinvestment relief allows deferral of an unlimited capital gain invested in a higher risk trading company.
4.36 However, there are many areas of overlap between these two reliefs and the range of investee companies is practically identical. Under present rules, companies can hold land and other property which reduces the risk of the investment, undermining the purpose of the tax reliefs and meaning that they are not well targeted.
Venture Capital Incentives
4.37 The Government proposes changes to existing venture capital schemes to encourage the provision of new equity capital and to ensure that the schemes are targeted in the most effective way.
4.38 The Budget proposes a new EIS which merges the former scheme with CGT reinvestment relief. Its main features are:
- increasing by 50 per cent, to £150,000 per year, the amount an individual can invest under the new EIS scheme and qualify for income tax relief;
- abolition of the limit of £1 million on the amount that can be raised each year;
- preservation of the best parts of the existing reliefs:
- up-front income tax relief, exemption from tax on gains after five years, and relief for losses against income or chargeable gains for outside investors and business angels who subscribe for shares;
- unlimited deferral relief where chargeable gains are reinvested in newly-issued shares;
- participation is limited to investment in companies with gross assets of less than £10 million before an investment and no more than £11 million after it.
4.39 The Government also propose better targeting of the new EIS scheme and the existing Venture Capital Trust scheme by excluding:
- arrangements which guarantee a substantial part of the return;
- some land or property-backed trading activities.
Promoting innovation and research and development
4.40 The Government recognises that investment is not just about building up the physical capital stock. Investment in research and development (R&D) is also an important element in promoting the UK's competitiveness and growth. Yet, as Chart 4.3 shows, whilst almost all of our major competitors have increased R&D's share of GDP in the past decade, the UK's R&D share has actually fallen.
4.41 The reforms to capital gains tax, corporation tax, and the other investment incentives outlined in this chapter are an important step towards creating a more favourable environment for investment and that will include investment in research and development. However, the Government recognises that there may be other steps that either it or business can take. That is why, in the Pre-Budget Report, the Chancellor and the President of the Board of Trade announced that they would be undertaking a wide ranging look at ways of improving the UK's record on investment in R&D.
Review of Research and Development
4.42 As the first step in this process the Treasury and DTI are jointly publishing today a consultative document, "Innovating for the Future", which identifies issues which it is the Government's intention to consider over the next year, including in the various working groups on investment and competitiveness sponsored by the DTI and the Treasury. The views of business and others are invited on the issues raised.
University Challenge Fund
4.43 The UK also needs to improve its record of exploiting the ideas generated by its many world class scientists and universities. This Budget announces a new University Challenge Fund which will help universities bridge the funding gap which can prevent them successfully transforming good research into good business. Under this scheme to create £50million in venture capital, universities will be able to compete for up to twenty seed venture capital funds. The scheme is a partnership between the Government, providing £20million, and the Wellcome Trust and Gatsby Trust, together providing an additional £20million. These contributions will lever in additional funds raised by Challenge-winning universities, in partnership where possible with the private sector.
Management recruitment incentives
4.44 The Government recognises the need to encourage top quality managers to join high-technology SMEs. It will therefore consult on ways of incentivising managers through equity based remuneration.
Helping Business - Better Advice and Better Services
4.45 The Government can play an important role in improving business performance by helping to remove barriers to growth. Regulatory burdens can involve significant costs for business, smaller companies with fewer staff and resources may face disproportionate costs. The Government is determined to ease these burdens by:
- helping businesses to comply with rules;
- abolishing unnecessary rules;
- simplifying rules.
Helping business
4.46 Helping businesses to comply with rules by providing them with advice and assistance is an important way in which government can ease the burdens of compliance. The Government is committed to looking for new ways to do this by providing better, more coordinated advice and adapting government services to new technologies and working methods.
4.47 Many businesses say they want to deal with one organisation about the tax and national insurance contributions (NICs) they collect from their employees. The Contributions Agency will therefore be transferred to the Inland Revenue in April 1999. Separately the Government is also committed to transferring the related NICs policy functions to the Inland Revenue once agreement on a new entitlement test for benefits has been reached (the Department of Social Security would retain responsibility for benefit entitlement). These transfers will further improve customer service through unified delivery of guidance and assistance, and speed the pace of tax and NICs alignment.
4.48 This Budget announces an important new payroll service which will help reduce costs for new employers. The service from the Inland Revenue is for small businesses who want to take on their first employees.
4.49 This announcement follows the early findings of an experimental service running in Leicester with employers who were not using professional help with their payroll. The service offers a range of advice to new employers including help with the employer's first pay-day, and one-to-one assistance with a wide range of other subjects such as Statutory Sick Pay, Statutory Maternity Pay, expenses, and benefits in kind. The experimental service will be offered in more areas during the coming year and will be rolled out nationally from April 1999.
4.50 The Employment Service will also take active steps to put employers, considering taking on young people under the New Deal, in touch with this service.
4.51 Increasingly businesses and individuals are managing their financial affairs electronically, using the telephone and computer, rather than just paper. So:
- an experimental call centre is being set up at East Kilbride, the first of its kind in the public sector. The experiment will test whether the Inland Revenue can use telephone call centres to deliver better, more flexible customer service and should reduce costs for members of the public by providing a quicker and more attractive alternative to doing business on paper. It will handle calls from all Scottish employers and employees - more than two million taxpayers. The Call Centre will come into operation in stages over the period late Summer 1998 to early 1999;
- from this August some taxpayers will be able to make claims and supply documents electronically rather than on paper.
4.52 The Government wants to ensure that businesses run by all sections of the community are able to benefit from the best information on their tax affairs. Customs and Excise is expanding its comprehensive introductory package for newly registered VAT businesses by developing further video aids in English and seven minority languages.
Simplifying rules
4.53 This Budget also announces further measures which reflect the Government's commitment to simpler and better regulation. For example:
- from April the Schedule A rules applying to corporation tax will be modernised and simplified to bring them closer into line with those for income tax;
- to assist companies prepare to make the changes for self assessment the legislation catering for self assessment for companies is to be restructured and written in clearer, easier to use language;
- from April 1999 the structure of employer and employee NICs will be simplified.
4.54 A detailed list of further tax simplification and abolition measures is set out in Annex C, The Budget Measures.
VAT threshold
4.55 The Government will consult on the VAT registration threshold and its impact on competition between registered and un-registered businesses. In the meantime the annual turnover threshold, above which traders must register for VAT will rise from £49,000 to £50,000 and the deregistration threshold will rise from £47,000 to £48,000 from 1 April 1998.