Strategy & Operations » Governance » FDs assess coalition government

What do finance directors want from the new government? Common requests are for certainty and stability. Britain’s new Conservative-Liberal Democrat leadership, the first coalition since 1945, has promised stable government that will reduce the country’s gaping budget deficit, while ensuring economic recovery.

But working out what the new government could mean for FDs is tricky. Political conventions are being discarded, policies ditched, while economic policy is more fluid than usual.

A Con-Lib Dem coalition document setting out its key ambitions published in the days following the announcement of the coalition outlines key tax and economic policies – including a surprise rise in capital gains tax (CGT). But details of some policies remain unclear. And with two key economic portfolios held by Liberal Democrats – Vince Cable stepping into Lord Mandelson’s shoes as business secretary and David Laws as chief secretary to the Treasury, serving, supposedly, shoulder to shoulder with George Osbourne as the chancellor of the exchequer – the tone and strategy of the Treasury is still being shaped.

Meanwhile, speculation mounts about a future hike in the VAT rate, which now seems inevitable. Tax experts are reserving judgment on the coalition government until the emergency budget, to be held on 22 June, and the Finance Act to pass the measure into law, which normally comes one month later.

Top of FDs’ concerns will be whether the coalition honours the promise the Tories made to cut corporation tax from 28 percent to 25 percent, or from 21 percent to 20 percent for smaller businesses.

“That would have an immediate effect for the business of the FD. It will be intriguing to see how much the [coalition government] wants to push this through,” says Francesca Lagerberg, head of the national tax office at Grant Thornton.

Vital agreements
“The parties appear to have reached agreement on some of the most contentious taxation issues which is vital for us and our consumers,” says Brian Mullens, UK finance director at McDonalds. “Agreements on income tax, national insurance and inheritance tax are less important than the fact that we now have certainty which allows us to plan. The challenge for the new administration will be to continue this approach through the emergency budget and comprehensive spending review, so that consumers and businesses know where they stand.

“We do need to tackle the deficit sooner rather than later, but in a way which doesn’t jeopardise the recovery. It’s just like having a credit card at home: you need to start paying it off before it gets out of control, but in a way that doesn’t threaten the mortgage,” he adds.

The coalition’s policy agreement says CGT for non-business assets, such as shares and second homes, will rise. Currently 18 percent, it is expected to be pegged to the income tax rate. This will help pay for increasing the personal allowance for income tax, a key Lib Dem economic policy. Any increase in CGT, which would hit the pockets of many FDs, would normally come at the beginning of the financial year in April, though Grant Thorton’s Lagerberg thinks the government might decide to increase the rate before then.

Bob Eastoe, finance director at bed manufacturer Hypnos, thinks the Tory-Lib Dem pairing in the Treasury could create an economic dream-team.

“Labour’s planned increase in national insurance contributions was definitely a tax on jobs and would clearly be a cost to our business which we can’t afford, other than reducing our numbers,” says Eastoe.

Concerns over what direction the coalition will take – and if it will take one – remain high. Vince Cable, the new business secretary, is on the left wing of his party and is far more interventionist on the economy than the chancellor, George Osborne.

“I think both parties have got the message that they need to set a direction, and that may be, for example, that we need a good internationally competitive tax system for business,” says John Whiting, policy director at the Chartered Institute of Taxation (CIoT). He thinks FDs should watch for changes to rules on tax avoidance and tax havens – the Lib Dems have claimed they can raise about £4.5bn by grasping the latter nettle – and new environmental taxes. “We all know that life is going to be tougher [for business], but can we minimise the uncertainty?”

City reaction
The effect on business of the coalition’s economic policies will, of course, also be determined by the reaction of the City and global financial markets. On the day the new coalition government published the first draft of its policies, the FTSE-100 finished nearly 50 points higher.

Some in the private equity world have questioned if an increase in CGT really would boost receipts for the taxman. According to figures from the British Venture Capital Association (BVCA), since 2007, when the Labour government raised the rate from 10 percent to 18 percent, tax revenues from CGT have more than halved, from £5.3bn in 2007-08 to £2.5bn in 2009-10 so far.

The BVCA urges the new government not to make any “hasty decisions” over the rate and wants it to confirm that capital gains made by private equity and venture capital will be classed as “business” for tax purposes.

A CGT increase could also coincide with an increase in the VAT rate to 20 percent. The day after the coalition government published its policy document, one powerful voice, Sainsbury’s chief executive Justin King, said he thought the hike to 20 percent was “more likely than not”. He called on the government to announce it soon so that retailers have time to prepare, but there are rumours that some retailers have changed their product pricing in preparation already. A BBC poll of 28 economists found 24 expecting the rise before the end of 2011, while estimates from some analysts put the value to public coffers from the rise at around £11.5bn.

“If the government wants to do something quickly, then VAT is a logical tax to look at,” says Lagerberg. “You can raise a lot of money quickly and in theory, it’s a voluntary tax, although it can have a disproportionate hit on people with lower incomes because there are some things that you do have to buy to live.”

However, the coalition government may have a bright side for FDs, who have long complained that the government is perpetually tinkering with the tax system only to make it more complicated.

“Once you get through the first choppy waters of the coalition, you might find that you don’t have as much change as perhaps one individual party would look to do,” Lagerberg adds. “The checks and balances in government will make it more difficult to put radical proposals through. Many businesses want less change.”

The Institute of Directors (IoD) welcomes the partial reversal of Labour’s national insurance contribution increase, but says it would like to see a full reversal, paid for with deeper spending cuts. But it says that there is too little detail on the CGT proposals for the full implications to be understood. It also calls for the government to define the ratio of planned spending cuts compared to tax rises for reducing the deficit. The coalition agreement document says that the “main burden” of deficit reduction will be borne by reduced spending rather than increased taxes.

“If [the main burden] means a 4-to-1 ratio in favour of spending cuts over tax rises, as implied by the Conservative manifesto, this should be welcomed,” the IoD says. “But if main burden means a lower ratio, such as 2-to-1 or 1.5-to-1, we would be concerned that the government’s intention is to tackle the deficit with an over-emphasis on tax rises. This latter approach would jeopardise both short and long-term economic growth.”

Despite supporting the UK remaining out of the euro, the business climate in the UK will continue to be swept along by events affecting the eurozone and the euro currency.

Greek contagion?
In May, European governments and the International Monetary Fund agreed a €750bn package to defend the currency from the very real possibility of collapse as the crisis in Greece and other eurozone members raised the risk of contagion.

The plan, welcomed by the markets, is designed to prevent the crisis that engulfed Greece from spreading to other indebted nations such as Portugal, Spain and Italy.
Could the UK face a Greek-style economic crisis?

“All European countries can learn something from this crisis, but you cannot compare the UK to Greece,” McDonalds’ Mullens says. “It does, however, highlight the deficit and private debt levels in the UK. The new government will undoubtedly need to ‘rebalance’ the public budget, which could put severe pressure on purchasing power and consumer confidence.”

In the UK, corporate insolvencies are set to rise, according to one expert – and there is little the new government can do to prevent this.

Nick Hood, executive chairman of Begbies Global Network, the corporate recovery specialist, says that the period of recovery after a recession is the most dangerous for businesses because they struggle to get extra capital from banks to meet increased demand from customers.

“If you look at the statistics for corporate insolvencies for all of the recessions for the last 40 years, you will see that corporate insolvency spikes between a year and two years after GDP starts to grow again,” Hood says. “It seems counter-intuitive, but the reason is blindingly obvious. [During an economic recovery] companies breathe a sigh of relief and completely forget that they need more working capital from the bank or factoring company. The real trouble with this recession is the level of damage caused to the financial and banking sector. It means that, unfortunately, there just isn’t as much liquidity as the market needs. “Either FDs leave it too late to apply for the money, so when they do apply they’re a distressed borrower, or they are at the back of the queue [for more capital].”

On pensions, the coalition government has publicly stated that it will establish an independent commission to review the “long-term affordability of public sector pensions”, while at the same time protecting accrued rights. It has also said that it will phase out the default retirement age and hold a review to set the date at which the state pension age starts to rise to 66, although it will not be sooner than 2016 for men and 2020 for women.

The National Association of Pension Funds supports much of the government’s pension’s proposals, but says that there is “little evidence of the bold thinking needed to restore workplace pensions to the heart of retirement-saving in the UK.”

It adds: “The emergency Budget will be crucial in determining whether the government has the resolve to put pensions at the heart of the new administration and create stable conditions for pensions-saving in the UK over the long term.”

The new coalition government has made a confident start and has been broadly welcomed by business groups. FDs will be hoping for a cut in corporation tax and bracing themselves for a hike in VAT. There is still plenty of economic and political uncertainty that business dislikes.

In Britain, coalition governments have tended to collapse after a few years. FDs will be tempted to delay investment decisions for a couple of months until the tax and business policies of the new government become clearer – if we don’t face the prospect of another election because, as some predict, the coalition falls into disarray.

The headline tax and business policies
• “Emergency budget” on 22 June – 50 days after the coalition agreement
• Additional cuts of £6bn to non-frontline services in the financial year 2010–11, subject to advice from the Treasury and the Bank of England on their “feasibility and advisability”
• The rise in National Insurance Contributions outlined by the Labour government will be reversed for employers – but not employees
• The Lib Dem’s flagship economic policy of a £10,000 starting rate for income tax will be phased in. The tax-free personal allowance for income tax will see a “substantial increase” from April 2011. Increasing the personal allowance to £10,000 will be a “longer-term objective”
• Capital Gains Tax (CGT), currently 18 percent, will rise for non-business assets, such as shares and second homes, to help fund the increase in personal tax allowances. It is expected to be pegged to income tax rates
• Tackling tax avoidance will be a priority, including development of Lib Dem proposals. Before the election the Lib Dems claimed that they could raise about £4.5bn by tackling tax avoidance
• An independent commission will be set up to investigate the issue of separating retail and investment banking