UK: Corporation tax suddenly in the spotlight in Tory leadership race.

As published on investorschronicle.co.uk, Tuesday 12 July, 2022.

In the weeks and months leading up to Boris Johnson’s resignation as prime minister, myriad fault lines opened in the party of government.

But among the rancour around the Northern Ireland protocol, managing the cost-of-living crisis and propriety in office, the question of corporation tax was barely mentioned. Now, within days into the Conservative party leadership contest, the levy on business profits has emerged as a key battleground for those vying to succeed Johnson.

While likely to be well-received by investors in the shares of UK-based companies, proposals to cut corporation tax have been met with a mixture of scepticism from economists, business leaders and politicians on both sides of the aisle.

There is one obvious reason why corporation tax has emerged as a defining issue: it allows challenger candidates to define themselves in opposition to the front-runner, Rishi Sunak.

The former chancellor, whose resignation this month helped precipitate Johnson’s ousting, is campaigning with a pledge to stick with his policy to increase corporation tax from 19 to 25 per cent between 2023 and 2025. He announced the plan last year to help pay down more than £300bn emergency pandemic spending, which he described as “morally, economically [and] politically” unsustainable.

While seeking to paint Sunak as a tax raiser, his opponents have promised to abandon those plans or go even further. Both foreign secretary Liz Truss and the current chancellor Nadhim Zahawi have pledged to scrap the planned increase, while Sajid Javid has said he wants to progressively pare down the profits levy to 15 per cent.

Jeremy Hunt, the former health secretary and a serial entrepreneur outside of politics, has gone one further by promising to immediately reduce the rate to 15 per cent.

A lower profits levy, if introduced, would have two effects on companies operating in the UK. First, and all else being equal, higher post-tax earnings would increase the capacity for capital investment, dividends, buybacks, and debt repayments. Second, a revision in tax forecasts would boost the net present value of assets, as a lower discount is placed on the future value of cash flows.

In theory, both effects would be positive for equity returns, particularly for the domestic stocks which make up the FTSE 250.

Whether tax cuts would prove in companies’ longer-term interest is up for debate, however. While those in favour of lower taxes have suggested cash will be recycled into capital spending, some may use it to meet rising debt costs. There is also growing pressure on companies to raise worker pay, which could further exacerbate inflation in an already tight labour market.

There is also debate whether the more aggressive plans could ever get off the ground. Claire Walker, co-executive director of the British Chambers of Commerce, told the Financial Times a 15 per cent tax rate “could place the UK in breach of new international agreements”, while some commentators have claimed a low tax rate would result in the leaching away of revenues to other countries.

The knock-on effect on government borrowing is also unclear. In a note to clients, DBRS Morningstar analysts questioned whether scrapping the planned hike in tax “could delay the return to a healthier fiscal position”. Others have called for more targeted fiscal policy to combat consistently weak domestic business investment.

In an open letter, Confederation of British Industry director general Tony Danker urged candidates to “show how growth policy is more than” tax cutting. While in favour of a “globally competitive and effective tax regime”, Danker argues corporation tax should be seen alongside business rates and NI costs, and for “a permanent successor” to the super-deduction rebate on capital spending.

Which firms use the super-deduction is often determined by both sector and company size.

Just 13 per cent of small and medium enterprises polled by Nucleus Commercial Finance said the super-deduction had spurred them to increase investments. Asked why they thought UK companies consistently invest a lower proportion of GDP than other developed countries, a majority cited economic uncertainty, with only 34 per cent pointing to a high tax burden.

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