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Dividend tax debate in House of Commons
by Susie Hughes at 08:15 13/07/04 (News on IR591)
The controversial dividend tax, also known as IR591, continued to attract attention in the House of Commons during the remaining stages of Finance Bill, when the LibDems tabled an amendment to reduce the 19 per cent tax level to five per cent.
Although the amendment was withdrawn without being put to the vote, it did serve to illustrate the stength of feeling - on both sides - of the House about this measure.

The debate relates to the Budget announcement that the Government intended to U-turn on the zero rating of incorporated small businesses because they felt people were taking advantage of the situation and paying dividends rather than reinvesting in their businesses as the Goverment had intended. (For comprehensive news on the developments surrounding IR591, see Shout99's 'News on IR591')

LibDem spokesman, Vincent Cable, who tabled the amendment to Clause 28, claimed to be looking for a more elegant way for the Government to back down. He also claimed it had antagonised several groups at the same time including those who incorporated in good faith; those who were already incorporated before the zero tax incentive was introduced; and those who are not incorporated but are still treated differently.

He claimed that there are two fundamental problems with the Government's approach. First, that there was a likelihood that there would be another change to the tax regime in the near future following the Government's review on owner-managed businesses; and secondly, that the change will be complex and disruptive.

Conservative spokesman, Howard Flight, claimed that the original zero rate was introduced as a piece of spin by the Government to make it look small-business friendly. He reminded the Paymaster General, Dawn Primarolo, that she had told small businesses not to look a gift horse in the mouth, and that the Government had failed to heed the warnings at the time that they were distorting the tax system.

Paymaster General, Dawn Primarolo, was not to be swayed by these arguments. She refuted the idea that it was complex, and claimed that the amendment to change the 19 per cent level to five per cent indicated that there was agreement with the principle of the approach.

There was also a squabble about the recent meeting of the All Party Parliamentary Small Business Group, which was attended by the Paymaster General, who heard a presentation about the concerns of small businesses. (See Shout99 report here: Minister hears about problems facing small businesses). She wished to point out that she was not a member of the Group and had attended as a courtesy, without making any comment.

The full debate

Dr. Vincent Cable - tabling amendment
Vincent Cable, LibDem MP for Twickenham said: "I beg to move amendment No. 38, in page 23, line 26, leave out '19%' and insert '5%'.

"My hon. Friend the Member for Yeovil (Mr. Laws) spoke on this subject at some length in Committee, and I should like to say a few words on it now. Our aim is to find a somewhat more elegant way to back down than the Government have found in their retreat on the zero rating of incorporated companies in respect of corporation tax. We know the story - I need not rehearse it at length - but the policy has had disastrous consequences. There was a 45 per cent. increase in incorporation in a year and an estimated revenue loss of 1 billion. The Government have had to retreat, and they have chosen to do by introducing a differential tax rate, with a 19 per cent. duty on distributed profits from small incorporated companies, which affects hundreds of thousands of companies that draw their incomes from distributions.

"The issues of principle have been debated backwards and forwards. What has emerged very clearly is that the Government's U-turn has managed to antagonise several groups of people simultaneously for different reasons. First, there are all those people who incorporated their companies in good faith because they believed the Government's arguments in support of incorporation. They invested in financial advice and the associated costs. Having followed the Government's advice and responded to the incentive that they were given, the overwhelming bulk of those who draw their income in the form of dividends now find themselves penalised by a high rate of tax.

"Secondly, those whose small companies were already incorporated before the tax inducement and were perfectly happy with that status now face an additional, different and more complex tax regime than before. Thirdly, those with unincorporated companies who felt a sense of grievance that they were treated differently from incorporated companies still feel that they are treated differentially. If they plough back their profits into their companies, they are taxed in a way that incorporated companies are not.

"There has been a general sense of frustration about the way that the matter has been handled. Clearly, the Government have had to beat a retreat; the issue is, how should they do that while causing minimum disruption and complexity? We tabled the amendment - my colleagues tabled a similar one in Committee - to try to find a somewhat better way.

"There are two fundamental problems with the route that the Government have taken. First, they have introduced another change to a system that must almost certainly change again in the future. I understand that they are undertaking a review of the issue - that is prudent and necessary - but the review will probably take a year to complete. There will presumably be a consultation document, and the tax regime may well change again. The context is that the tax on such companies has already changed four times in quick succession: from a rate of 20 per cent. to one of 10 per cent; to a zero rate; and now to a zero rate plus the extra tax on dividend distributions. There is a high rate of flux, with all the associated costs of accountancy and financial advice. The Government propose to make another big change. Would it not better to hold off and make a much more modest adaptation of the type that we propose?

"There is a second complexity. Those in industry and the Inland Revenue have been involved in a vigorous debate about tax complexity and whether the Government's proposal will make life extremely difficult for those in small businesses. The Select Committee on Economic Affairs produced a thorough report on the issue. It has no particular axe to grind. It is an all-party report and no voting was involved, so we are dealing with people who considered the issue in a fairly detached way. I shall simply quote a couple of references from the House of Lords report, which gives a reasonably balanced assessment of the complexity produced by the Government's changes. Paragraph 135 says:

"From the evidence we have received on the issue of technical complexity we noted that there was no meeting of minds between our private sector respondents and the Revenue. In our view, this issue falls to be judged in the context of the population of taxpayers (up to 332,000 owner-managed companies . . . ) who are going to be affected by it".

"The report continues:

"all our witnesses from the private sector who spoke on this subject expressed the view to us that a straightforward abolition of the 0 per cent. rate would be a much simpler way of achieving essentially the same end result as will be produced by these provisions."

"It is clear from those whom the change will affect that it will be complex and disruptive, and there will almost certainly have to be another change after the review. The amendment would ease the process, making it somewhat more elegant, and less costly and difficult for people who run small companies.

Howard Flight - "Piece of spin"
Mr. Howard Flight (Arundel and South Downs) (Con) said: "This saga is illustrative of some of the main problems with the Government. The original zero rate was introduced as a piece of spin to try to claim that the Government were small-business friendly. Indeed, we all remember the Paymaster General telling small businesses not to look a gift horse in the mouth. The Government failed to heed warnings given at the time by everyone, including the official Opposition, that they were distorting the tax system in favour of incorporation. Unsurprisingly, the tax loss when thousands of sole traders incorporated has turned out to be far too great, so a piece of tax complexity is required to negate that - the Lord giveth, and He taketh away, so the gift horse has gone.

"I believe that the Paymaster General attended a recent conference for small businesses, and as the hon. Member for Twickenham (Dr. Cable) pointed out, many small businesses said that they would rather abolish the zero rate and return to a simple situation rather than being burdened with complex arrangements while the Government undo their mistake. The amendment would not solve the problem and it has tax-revenue implications. It would be far better if the Government were to be a little more brave and honest by addressing the problem of their own making more satisfactorily."

Dawn Primarolo - "Simple and straightforward"

The Paymaster General, Dawn Primarolo said: "The hon. Members for Twickenham (Dr. Cable) and for Arundel and South Downs (Mr. Flight) advanced two sets of opposing arguments, and I shall deal first with the points made by the hon. Member for Twickenham. It is a complete fallacy that the introduction of the small companies rate makes calculations for companies more complex - it does not. The scheme is extremely simple and it works through the corporate tax system. The system is straightforward for companies that start as micro-companies, reinvest in themselves and grow, because the zero rate will be left in place to assist such companies.

"I know that the hon. Gentleman would agree that small businesses promote growth and enterprise. They are part of a modern, dynamic economy that needs a strong entrepreneurial base and vibrant small businesses. The Government's policy is designed to ensure that the significant engine for future growth in the economy, which generates the competitiveness that drives innovation, is rewarded when profits are reinvested in companies.

"The fact that the amendment would change the rate to 5 per cent. suggests to me that the hon. Gentleman accepts the principle regarding companies that are driven to incorporate only to access low corporation tax rates when taking a dividend as private income rather than reinvesting in themselves. He is merely quibbling about whether the rate should be 19 per cent. or 5 per cent., but he does not address how costly his scheme would be, as the hon. Member for Arundel and South Downs pointed out, despite the fact that it would have no purpose. The measure would cost about 500 million in 2006/07, and there would be a substantial cost due to those who were driven to incorporate not because they wanted to reinvest profits in their companies to promote growth, but so that they could access a 5 per cent. tax rate and thus reduce their liability for tax on their incomes. That cannot be right.

"The hon. Member for Twickenham set the two benchmarks of complexity and a further change, but he contradicted himself. He would increase complexity by setting a rate of 5 per cent., for which there is no parallel in the tax system for corporates, and would also make a change, which he says that he does not want. For reasons of cost, fairness and the need to reward companies that reinvest profits in themselves to promote growth, the Government's policy is the fairest and the most straightforward option. The changes to which he referred have nothing to do with small businesses that try to invest their profits for growth. Specific aspects of the tax system needed to be addressed because some companies were trying to remove profit in other ways, and thus escape tax, which cannot be fair.

"The hon. Member for Arundel and South Downs talked about the zero rate, but his party did not vote against that proposal. It agreed with the principle that we should assist companies that reinvest their profits in themselves in order to grow. I fail to understand how removing the zero rate, yet keeping the 19 per cent. rate, would assist such small companies.

Howard Flight - incentives
Mr. Flight said: "With the greatest respect, I think that the Paymaster General was present when I said that several small companies have commented that they would prefer to be rid of the 19 per cent. rate, which can be complicated in some circumstances, at the price of giving up the zero rate. She knows that one rate essentially offsets the other. Secondly, when the zero rate was introduced, we said that if the Government wanted to give tax incentives to small businesses, they should not distort the tax system, but give incentives, whether companies were sole traders or incorporated.

Dawn Primarolo - buying a few friends
Dawn Primarolo said: "I am glad that the hon. Gentleman mentioned what was said at the meeting of the all-party group on small business - that was the occasion to which he referred - because much mischief has been made, so I would like to put the facts on record. I am not a member of the all-party group, but the hon. Gentleman's colleague, the hon. Member for Hertford and Stortford (Mr. Prisk), is. Several professional organisations attended the meeting, including one lobbyist and two, three or perhaps four representatives of such bodies as the Institute of Chartered Accountants. The Federation of Small Businesses was also represented at the meeting. The hon. Member for Hertford and Stortford asked me, as a courtesy, to attend the meeting to hear what those bodies had to say. They did not purport to represent, or speak on behalf of, all small businesses, and they did not suggest that they wanted the zero rate to be removed. I made no comment on that at the meeting, so let us be clear that people are not lobbying for that measure.

"The amendment is an attempt to buy - literally - a few friends with taxpayers' money. It would affect only a small sector of companies that would prefer not to pay the same tax as everyone else has to. I do not think that that is fair. It is complex and the Exchequer, on behalf of all taxpayers who pay their fair rate of tax, rejects it as a principle. However, I look forward to debates in future with both hon. Gentlemen about the most appropriate for the tax system to respond to micro, small and medium-sized companies with regard to their contribution to the economy. If the amendment is put to a vote, I shall ask my right hon. and hon. Friends to oppose it."

Vicent Cable - Government created problem
Dr. Cable said: "There is an element of common ground. All three of us - the Minister, the hon. Member for Arundel and South Downs (Mr. Flight) and myself - are concerned about how best to create an environment in which entrepreneurs can flourish. One of the painful lessons of the Government's attempts at tax reform is that simply switching artificially from incorporation to unincorporation, treating them as entirely different animals, merely results in distortions of the system and does not promote entrepreneurship.

"Neither the Minister nor I are the best people to judge the issue of complexity; it is those on the receiving end who are best able to judge complexity. It is clear from the evidence that has come forward from the various representative and professional bodies that an enormous amount of complexity is involved. The Inland Revenue describes its three-step process for calculating tax liability as extremely simple. However, it is extremely complex for many people who cannot afford to employ an accountant and have to go through the process themselves. Clearly, there is a difference of interpretation of complexity in this context, but it is clear to most people who run businesses that the arrangement is extremely complex.

"As for reinvestments, it is a little simple to say that there are good and virtuous companies that reinvest their profits and others that take dividends. Until the Government started tinkering with tax arrangements in this area, where many small companies were highly entrepreneurial, some people took their income in the traditional way and paid income tax on it, and others took their income in the form of dividends. That reflected the old system. It does not mean that one company was better than another or that one was more committed to growth than the other. The argument about reinvestment and non-reinvestment is artificial.

"As for the amendment's revenue implications, it is fair to say that the Government's track record of predicting the revenue implications of tax changes have not been particularly good. They lost 1 billion as a result of the inadvertent changes from their own proposals, so to tell us that the amendment would somehow be depriving the Treasury of revenue is a little rich. The problem that the Government now face is how to extricate themselves, as sensibly as possible, from a mistaken initiative. We know that within a year or so the regime will have to change again, and we are looking for the most sensible transitional arrangement. The Government have proposed a complicated one, and ours is rather simpler.

"I do not intend to push the amendment to a vote, but it is worth reminding the Government that they created the problem. We are trying to help them to find a way out of it. I beg to ask leave to withdraw the amendment."

The amendment was withdrawn.
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Susie Hughes Shout99.com 2004

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