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FDs fear current Budget’s lack of detail

The General Election on 6 May is, of course, widely believed to be the reason why this year’s Budget on 24 March was so devoid of any unpleasant surprises. For the most part, the financial community agrees with the belief that a lot of the policies are temporary vote winners rather than offering any long-term impact, and that the ‘real’ Budget will surface after the Election – probably some time in June – regardless of which party wins.

What of the government’s pledge in the Budget to increase business lending targets for state-owned banks? Some finance directors are concerned about this pressure and believe that their own banks may use aggressive tactics to try to obtain margin from existing customers, punishing businesses that have managed prudently through recession, rather than from new business.

One FD, who preferred not to be named, has told Financial Director of the pressure his cash-rich company had already faced at the onset of the recession, when the company’s bank unexpectedly increased the margin on a performing loan. He says it became an “ongoing operational burden, causing one argument after another”. He is dismayed at aggressive banking tactics.

Chartered accountant and consultant Rakesh Gulati – who has been an FD – calls them “total hot air”.

Peter Barry, finance director of food waste management systems manufacturer Meiko UK, also believes the policy is thin on substance. “It’s playing to the crowd,” he says. “How would they enforce it?”

The problem, as Barry points out, is not so much that lending targets need to be increased – but that the margins charged on bank borrowing are so high, banks’ sensitivity to anything appearing risky may scare them off.

“Companies are not prepared to borrow at the current rates,” he says. “Previously, banks were lending at, say, one percent above base rate. But now banks are trying to rebuild their balance sheets, so even with a base rate of 0.5 percent, they are lending at, for example, a five percent interest rate, while paying 0.2 percent on deposits.

“It’s not that banks won’t lend the money. A lot of companies still cannot borrow as the cost of capital is too high. That’ll be a big drag on the recovery. The idea that you can force state-owned banks to lend … is unworkable.”

Banking priorities
On a non-tax point, the chancellor announced the increase of targets in business lending from state-owned banks, including Lloyds and HBOS – a move that raised eyebrows and even sparked fury among some FDs.

But Brian Capon, assistant director at the British Bankers’ Association (BBA), thinks the new lending targets are likely to have little effect on the way banks lend, agreeing that the issue is lack of demand rather than supply. “Certainly, some larger companies, have been going directly to the capital markets to raise the funds they need, rather than turning to banks,” he notes.

Gulati proposes a different solution. “For economic recovery to continue, we need free flow of capital,” he says. “At the moment, banks will be building up their capital ratios. The solution would be to reduce banking ratios.”

The Budget was even devoid of some widely-expected announcements. Tax changes that business leaders had expected were shelved for the time being as the standard rate of VAT remained at 17.5 percent, Capital Gains Tax (CGT) stayed at 18 percent and the 0.5 percent rise in National Insurance came into effect.

Certainly from a tax point of view, May could well be the last month that the policies from March’s Budget will affect companies, individuals and the economy. Would, for instance, a much-expected rise in CGT mean a rush of high-earners looking to take advantage of the disparity between that and the 50 percent top rate of income tax? After all, as Meiko UK’s Barry points out, those earning between £100,000 and £112,950 are paying an effective tax rate of 61 percent – and may well now seek to remove themselves from that bracket.

Observers concur. “Some individuals looking to take advantage of the CGT rate may at least wait until the results of election day and if there is going to be a rush… they may well wait till mid-May,” says Richard Baron, head of taxation at the Institute of Directors (IoD). Baron, however, is less sure that CGT will change.

“It’s certainly difficult to guess what may or may not happen,” he says. “The government would get a really bad press for [changing] it. When the 18 percent rate came in a few years back, there was a furore over that, so whoever is in government may be wary of changing it again.”

He believes there is a “distinct possibility” that VAT may increase after the election, especially as an increase of just 1 percent would raise an estimated £4.5bn for HM Treasury. Many have argued that with the European Union average VAT standard rate being 20 percent there is plenty of scope to raise the UK rate by 2.5 percent. However, would a rise to 20 percent jeopardise any economic recovery by increasing the cost of living for the consumer?

VAT versus NI rise
Baron thinks any rise will be “as little as possible – tax rises are bad for the economy and could reduce growth.”

Conversely, Meiko UK’s Barry believes there “is not a strong case for arguing [a VAT rise] would damage the recovery” and thinks the 20 percent rate is imminent. Both he and Baron agree that the increase in NI rates would be far more damaging to the economy than any VAT increase.

“The government needs to get really tough on public spending rather than seek to raise taxes,” Baron adds. “However, while any tax rise could cause a reduction in economic growth, a VAT rise would be much less dangerous than an NI increase.”

Barry points out that the NI rise taxes jobs – and that “the number of jobs available are what will have more of an impact on economic recovery”.

Alistair Darling relaxed the rules on consortium relief in the 2010 Budget, in an effort to encourage UK companies to form joint ventures in Europe.

Squeezed, or not so squeezed
by Neil Hodge

Under the revised rules, companies based in the European Union and European Economic Area will be able to offset losses from a joint venture against profit elsewhere in the company – so long as a clear link can be established between the two parties.

The government says the amount of a loss that a company can write off should be in proportion to its share of investment in the joint venture.

Consortium relief has typically been used by technology, chemical and retail companies where joint ventures have been used to help fund the levels of investment needed while spreading the risk.

Previously, consortia could only qualify for relief if they could show a link between the two parties through
the UK.

The planned changes follow the Philips Electronics tribunal judgment last year. Between 2001 and 2004, the UK branch of LG Philips Displays Netherlands incurred losses, while Philips Electronics UK Ltd made a profit. Philips UK made consortium relief claims in order to offset its 50 percent share of the UK branch losses against its profits. HMRC contested this, but the tribunal overruled its argument.

Peter Cussons, international corporate tax partner at PricewaterhouseCoopers, says that the proposed change is welcome but it “should have been made at least ten years ago”.

He also says that the announcement is “qualified good news” as it is not set to come into operation until the next parliament, after the General Election.

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