Call for business finance tax reform

30 Apr 15

‘Perverse incentives’ in the tax system prompt private firms to prioritise debt over equity, ramping up the risk of economic instability in the UK, a report has claimed today.

The analysis by the CentreForum think-tank concluded that current taxation arrangements mean it is in a business’s interests to finance their operations through debt rather than through equity.

This is because investments in equities such as shares are taxed four times – through stamp duty, corporation tax, income tax and capital gains tax – but interest payments on debt are treated as a business expense and are tax deductible.

This ‘debt bias’ has encouraged an increase in corporate indebtedness in the UK, which in turn can lead to credit crunches and recession, CentreForum said.

It also stifles innovative small- and medium-sized firms in the early stages of development, when they often want to issue share capital.

Such companies need investors who are willing to share the risks and rewards of providing capital, making equity more suitable than debt, the Unbiased capital: making tax work for business report stated.

However, the tax bias pushes the cost of equity capital up, giving an advantage to old, established firms, CentreForum associate director Tom Papworth said.

‘How businesses finance their operations is crucial for enterprise. Our current tax system is strongly biased against equity and towards debt.

‘This fuels the over-indebtedness of our economy, exacerbating financial crises, and discourages the patient equity capital that market changing business start-ups need to succeed and grow.’

The report recommended the creation of a new Allowance for Corporate Equity, which would permit a certain rate of return on equity to be deducted against corporate profits. In addition, the current Stamp Duty Reserve Tax, which is paid on share purchases and increases the bias towards debt, should be abolished.

Welcoming the report, Adam Marshall, executive director of policy and external affairs at the British Chambers of Commerce, said businesses’ over-reliance on debt finance has been exacerbated by the tax treatment of equity financing for too long.

‘Providing that a clear framework is put in place, including a clear limit on the size of the equity investment, the introduction of an Allowance for Corporate Equity would be a welcome step toward providing our most promising businesses with the access to finance they need to reach their full potential,’ he said.

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