Government tax drives

Is the government taking entrepreneurs for a ride?
The UK national deficit is around 63 per cent of GDP and it’s going to be entrepreneurs who settle the balance through higher taxes.

The French may cry about liberty and equality, but nothing raises the revolutionary zeal of the British voter so much as the liberties taken by the taxman.

And given that the government’s coffers are now in dire need of replenishment, things are going to get decidedly ugly for entrepreneurs. The chancellor and HMRC are odds-on to keep turning the screw on those businesses that create this nation’s wealth.

Jos White, who with his brother Ben built up and sold their Gloucester-based IT security business, MessageLabs, to US giant Symantec in 2008 for £400 million, narrowly missed out on paying the lower rate of capital gains tax (CGT) after chancellor Alistair Darling raised it to 18 per cent two years ago (axing the taper relief that kept CGT at 10 per cent for long-term stakeholders). ‘It made a big difference to my brother and me,’ reflects White. ‘We thought we were really good candidates for taper relief and were the kind of people it was trying to incentivise.’

No respite

The concern is that CGT is going to be brought closer into line with income tax, which was moved up to 50 per cent for those earning £150,000 per annum or above. The expectation is for CGT to rise to 25 or 30 per cent, and that causes real concern for White, who now invests in growth companies through his VC firm, Notion Capital.

‘Twenty-five per cent would start to make the UK pretty uncompetitive in Europe. It’s fairly challenging for the venture capital industry right now, but I think it would be dead in the UK if CGT was as high as 30 per cent. I don’t think venture capital would stop; I just think it would go somewhere else,’ he says, including his own firm in the exodus. ‘It wouldn’t make any sense for Notion Capital to be in the UK.’

Mark Walters, a director at taxation and accounting firm Frank Hirth, is one of the many who think CGT will be higher. ‘Whether the chancellor will do it this year or not is another question,’ he says. ‘Politically, you could argue that it’s not too much of a problem for him as the folks making capital gains are already getting hit by the 50 per cent income tax rate. If they have to pay 20 to 25 per cent as opposed to 50 per cent, they’re still not “unhappy”.’

Andrew Hubbard, a tax specialist at RSM Tenon, warns that hiking CGT rates without well-targeted reliefs would have grave consequences for entrepreneurs: ‘My gut feeling is they won’t make any immediate announcement in the Budget. I suspect the real decisions will be made when there is a government with a five-year mandate.’

Rich man, poor man

The 50 per cent tax band on high earners infuriates Andy Pearce, the CEO of conference call company Powwownow: ‘In my opinion, it’s killing the rainmakers. My real worry is that what the government is doing will damage start-up entrepreneurs. In the early stages, you often go to friends and family to borrow money, but with a 50 per cent tax rate, it’s going to mean less cash to make a speculative punt.’
Walters observes that income tax over 45 per cent tends to be counterproductive. ‘In the US, they need to go higher than their existing rate of 35 per cent, but there’s no way it will exceed the highest rate of 39.5 per cent. They’re pretty wedded to the idea that if you leave someone with less than 50 per cent of every dollar they earn, it’s all going to become rather difficult.’

As an angel investor himself, Pearce says the high tax rates, combined with the changes to CGT, are acting as a disincentive to those who want to promote growing businesses. ‘Entrepreneurs generate the wealth and employ millions of people across the country. A lot of us work for a pittance in the early years and when a company turns round and starts earning proper money, we get it taken off us. I have invested in a number of small businesses over the past few years and I am now questioning whether I can afford to do that.’

Frontal assault

Higher taxes are never going to be popular. John Cheney, CEO and founder of web-based CRM company Workbooks.com, observes that he doesn’t ‘generally have a problem with the tax system’. For him, if an area needs to be addressed it’s the Enterprise Investment Scheme, which was set up to give private investors tax breaks to encourage them to put their money into young, fast-growing companies.

Although it’s worked well for Cheney, who in February raised the maximum amount of £2 million from angel investors under the scheme, he believes it could be improved. ‘Currently there is a limit of £500,000 per investor and we had investors who were willing to put more in but didn’t because they don’t receive tax breaks over and above that limit. Bearing in mind that this is a personal investment, I think it would be great if they could invest as much as they like. I don’t see a reason for the cap of £2 million on the total amount invested either.’

Lucian Tarnowski, the 26-year-old founder and CEO of recruitment website BraveNewTalent, recently raised £350,000 from angels, with all the stakeholders qualifying for EIS relief. He agrees with Cheney, saying that the scheme could be improved to make the fundraising process easier. ‘The government needs to send a clear message that Britain is a home for wealth creators,’ he argues.

Less is more

For the majority of entrepreneurs, it’s corporation tax, VAT (widely expected to rise to 20 per cent) and National Insurance that cause bewilderment, tears and frustration. Not least because of the complexity that follows each legislative and technical change.

‘Corporation tax is just insane,’ says Victoria Pooley, managing director and
co-founder of direct marketing company The Data Partnership. ‘If you make a £300,000 profit, you pay 21 per cent to the government. That’s £60,000.

‘If you have 15 staff and their combined salary totals £250,000, you’re obliged to pay 12.8 per cent National Insurance, which is another £30,000. To house those employees you’ve probably got around £15,000 of business rates on the property and then approximately the same amount in tax liabilities for directors. You’re looking at £120,000 of your £300,000 profit going to the government.’

Pooley is convinced that the tax burden is dissuading people from taking the entrepreneurial leap of faith. ‘It has to be a factor because when you look into tax liabilities, you’re left thinking, “Oh my God.” There are so many different thresholds and bits of red tape to wade through,’ she says, adding that she had to ditch her one-man finance team for a larger firm once the business expanded overseas. ‘As a company grows, especially with offshore call centres, tax becomes a massive headache and I now have a big accountancy bill to cover it all.’

Bobby Lane of professional services firm Shelley Stock Hutter takes a similar stance to Pooley, arguing for the government to introduce a National Insurance discount or holiday for the first year to encourage early-stage ventures to employ staff, and to reconsider the burden imposed by corporation tax on SMEs. ‘There’s no incentive for people to start a business,’ he concludes.

Gordon’s complaint

The running ‘gag’ among tax accountants when Gordon Brown made the jump from chancellor to prime minister was that at least Tolley’s Tax Guide wouldn’t get any bigger. During Brown’s decade at 11 Downing Street, the tax accountant’s bible more than doubled in size.

In reality, Brown’s tinkering has been good for the tax practitioner as it has created more work. The cost of hiring an adviser to understand the legislation and identify ways to pay less can be seen as another tax in itself. White of Notion Capital proposes that the government should subsidise tax advice for businesses, such is the degree of complexity that it has introduced.

While rises are inevitable, due to the mammoth deficit, RSM Tenon’s Hubbard believes that technical changes and reforms in forthcoming Budgets need to be kept to a minimum. ‘Fundamentally, business owners want to be left alone. Often a change is introduced to make things simpler but it ends up creating more cost and problems,’ he says.

Simplification is the way forward, but nobody in their right mind expects it to happen when the real recession-busting Budget is announced next year. Says Pearce, ‘The government is trying harder to remove opportunities for lower tax, such as starting businesses overseas without avoiding tax regulations.

‘First and foremost, I think government is inefficiently run and I reckon it’s not just entrepreneurs who would agree with me in this country. We need a shake-up.’

www.smallbusiness.co.uk

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