2 March 2021

A simple way to help businesses – without adding to the long-term debt pile

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Should we expect tax hikes in tomorrow’s Budget? ‘

In the last few weeks ‘sources close to the Treasury’ have floated raising almost every tax under the sun, aside from VAT, National Insurance and Income Tax, which are protected by a seemingly unbreakable Tory manifesto pledge.

But you shouldn’t believe everything you read during the traditional wave of pre-Budget kite flying. The weeks before a Budget are typically used to test the waters and manage expectations. Some ideas are perennially touted – a flat-rate pension relief is a classic – and never make it anywhere close to the final document.

If the Chancellor is wise, he will leave tax rises to another time, and it would be a particular mistake to hike taxes on businesses when the recovery is far from secure. The Office for Budget Responsibility’s forecasts of the economic impact of the pandemic and the lockdowns that came with it have already been changed significantly in the space of a few months. It would be better instead to focus on supporting businesses to protect jobs in the short term.

The top priority should be to extend existing temporary support such as furlough, business rate relief, and reduced VAT at least until all restrictions are lifted. But Rishi Sunak should go further and support businesses who have run up massive losses over the past year by allowing them to carry back their losses over the past three years. They would be able to offset their losses against past profits and benefit from a tax rebate.

This isn’t a new idea. It’s been used by the Treasury to address past recessions in ‘91 and ‘08. But it would make a tangible difference and, attractively, wouldn’t increase the national debt over the long term.

Encouragingly, the idea was backed in a Treasury Select Committee report published on Monday. It is also supported by the CBI, who endorsed the idea in their submission to the Select Committee.

In theory, it shouldn’t matter when a company makes their profit. A business that runs losses for a decade then makes a bumper profit in year 11 shouldn’t pay more tax than a business that made the same profit but spread evenly over 11 years. To ensure this doesn’t happen, most tax systems allow businesses to carry their losses forward to even out their tax bill over the years.

But the UK’s treatment is relatively ungenerous, and not for any good reason either. The annual deduction for carryforward losses is limited to £5 million plus 50% of the current year’s taxable income. Some larger businesses might not be able to offset the losses they’ve run up during the pandemic for a number of years. This is an issue because the value of the losses declines over time.

As the Centre for Policy Studies and the Tax Foundation note:

“Limiting carryforward losses changes the taxable income of a firm over time. A company that usually makes £100 million in profits, but has a £400 million loss in one year, will have to deduct those losses over several years. Instead of being worth £400 million as a deduction, the restriction lowers the net present value of the deductions to roughly £372 million.”

This counterproductive system is a recent change, allegedly designed to tackle tax avoidance, but experts such as the Institute for Fiscal Studies’ Deputy Director Helen Miller have been critical. “These measures – for which there is no good economic rationale – acted to boost revenues over the near-term from 2015–16 but to reduce them slightly over the longer-term.”

Letting businesses carry back their losses over the past three years would ensure inflation and a loss of interest payments do not erode the tax benefit from carrying forward their losses. This is important in the context of a sluggish and long recovery, where firms may not return to full profitability for a number of years.

In the short term, we should let businesses carry back losses over the past three years.  But the case for fixing the way we treat corporate losses stretches beyond the immediate aftermath of the pandemic.

Innovative venture capital backed start-ups and scale-ups often run large losses in their early years. In the case of Twitter, it took them over a decade to turn a profit. Under the status quo, disruptive innovators are penalised.

Eliminating Osborne’s irrational limits of losses would also make our tax system more competitive. One of the reasons the UK performs poorly on metrics such as the Tax Foundation’s International Competitiveness Index is the way our system treats loss-making businesses. This is an issue where we are out of step with the majority of the OECD.

Fixing this would make it easier for businesses to help us grow our way out to the crisis and make our tax system more competitive. And best of all, it would have a negligible impact on the budget deficit.

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Sam Dumitriu is Research Director at The Entrepreneurs Network.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.