A Taxing Problem

Posted on 20 Mar 2009 by The Manufacturer

UK manufacturers are clearly being battered by severe economic headwinds," says EEF's Steve Radley, "but they are also playing a long game..."

With the global recession in full swing, UK manufacturers are clearly being battered by severe economic headwinds. But they are also playing a long game: by braving the worst of the downturn, they hope to capitalise on the upswing and play their part in a better balanced economy.

Uncertainty a lack of demand and cash flow constraints are a toxic mix as far as investment plans are concerned. Companies are considering unconventional measures to hold off on redundancies for as long as they can, but it increasingly looks like investment could be a casualty of the recession. Further government support may be needed to ensure that the success of UK manufacturers is not derailed by deleveraging in the rest of the economy.

Part of the solution may be additional targeted and temporary measures to help manufacturers weather the tide of the recession. Less obvious, but no less urgent is supporting manufacturing investment with a more predictable and internationally competitive tax system.

At a time when most other countries are reforming their tax regimes to attract increasingly mobile investment, the UK’s regime continues to constrain actively manufacturing investment, compounding the credit crunch and limiting the extent and benefits of balanced economy.

Long-term risks

Unlike other businesses, manufacturers are exposed to a range of risks because they invest for the long run and are more internationally orientated. No business, however, can ever have complete certainty over its investments and markets. But the stability and predictability that manufacturers require has been met with repeated changes to taxation rates, rules and allowances. The ensuing lack of certainty and increased complexity have added to administrative costs and placed a premium on operating in the UK.

Over the last decade, for example, innovation and new technologies have rendered existing equipment obsolete, raising the cost of investment and forcing manufacturers to reinvest on ever shorter cycles. A wealth of evidence suggests manufacturers are replacing their equipment, on average, every eight years; many companies even faster. Yet recent changes to the tax system mean that it can take a business up to 29 years to recoup fully the costs of their capital investment. While this may seem like a simple timing issue, for manufacturers competing in global markets, cash is king and the difference adds to the cost of investing.

UK manufacturers would also benefit from a more deliberative policy process and a less adversarial approach from the taxman. Rushed policy measures and poorly drafted legislation have left scope for inconsistent interpretation and unintended consequences.

Unexpected reforms to the capital gains regime have undermined a decade of positive developments in promoting entrepreneurship, while small firms have experienced a rollercoaster ride of reforms to the small companies’ rate of corporation tax.

Tax only domestic activity

In sum, recent changes to the business tax regime have saddled manufacturers with rising costs, complexity, inconsistency and ultimately, uncertainty over the direction of tax policy. Smaller, less mobile companies have little choice but to bear this burden in the UK, but larger, more mobile manufacturers are beginning to be pushed abroad. The complexity associated with the Treasury’s focus on what should be taxed and where it should be taxed in a globalised economy is also pushing tax up the boardroom agenda. The simplest answer is to move towards a tax system that only taxes activity that happens in the UK.

Although moving to a corporate residence abroad would not be a body blow to manufacturing in the UK, it would further loosen its ties to this country. Just as functions such as design and R&D might eventually follow production abroad, other business operations could also follow board meetings to low-tax locations.

International tax competition is becoming increasingly important. If larger, more mobile manufacturers are pushed abroad, the strong supply networks left in the UK would inevitably suffer.

In the next decade, the opportunities for growth lie in tapping international markets and capitalising on growing markets, such as the shift to a low-carbon economy. Manufacturing has a natural advantage in these areas, but the severity of this recession puts its future success at risk. Manufacturers need to invest now to be competitive in the future. But with the tax system tilted against them, it is critical that the Government removes the barriers to investment if it really wants to build a better balanced economy.