Once upon a time, in a pre-Brexit, pre-Trump world, a conservative government unexpectedly won an election. One of their key priorities was to eliminate the deficit, and in the Budget immediately following the election they came up with a way to “raise” a few £billions by what amounted to an accounting trick.
They decided to change the timing of corporation tax (CT) payments for the largest companies, with profits over £20m. These companies currently pay their CT by 4 quarterly instalments, starting in the 7th month of their accounting year. The summer 2015 Budget announcement brought forward their quarterly payments by 4 months, to begin in the 3rd month, with the final payment just before the end of their accounting year. This change was meant to happen from April 2017, but the March 2016 Budget deferred it to April 2019.
The measure was explained, firstly, as being in line with the government’s strategy for tax administration, bringing the time of tax payment closer to the time at which income is earned, and secondly, as aligning the UK more closely with other G7 countries. The change provoked comments (e.g. p.9 of the Deloitte Budget commentary) that it would cause cash-flow issues for some companies, and also that the requirement to make the first payment before the first quarter’s results were known would lead to less accurate estimates and hence more variability in CT payments. The deferral to 2019 gave companies more time to prepare for the new payment schedule but did not alter the requirement to pay 4 months earlier.
The big prize from the government’s point of view could be seen from the relevant scorecard figures published in the summer 2015 Budget:
|Exchequer impact – orig||+4,495||+3,135||+140||+60|
The overall estimated impact was an increase in receipts of £7.8bn. When revised figures were published at the March 2016 Budget, pushing the timing effect out by 2 years, this overall impact had increased to £9.6bn:
|[simplified version of table]||2019-20||2020-21|
|Exchequer impact – revised||+5,965||+3,600|
The key point to note about these figures is that the apparent boost to receipts in the years in which the change takes effect is not a real increase but is entirely a matter of timing. Another way of thinking about this is that there will be a year in which companies affected by the change will have to pay 6 quarterly instalments of CT instead of 4. But there is no overall benefit to the Exchequer, except to the extent that it receives some of its CT 4 months earlier than previously.
A key element in making this accounting trick work from a public finances perspective was the fact that CT receipts have always been accounted for on a cash basis: that is, on the basis of the actual amount of cash received during the year.
This method of accounting for CT is out of line with other taxes such as VAT, which are accounted for on an accruals basis. Indeed, the Office of Budget Responsibility (OBR) recognised in March 2016 there was a risk of the whole thing unravelling. Its Economic and Fiscal Outlook, issued at the Budget, describes the long-term effect and uncertainties of the measure to bring forward CT payments (emphasis mine):
A19. As it has no effect on CT liability, the long-term yield would in effect be zero. Moreover, if CT receipts were recorded in the public finances data in accruals terms – aligned with the timing of the economic activity that gave rise to the liability – rather than cash terms (when the tax is paid) our baseline forecast would change and the yield from this measure within the forecast period would also in effect be zero …
Sure enough, the Office for National Statistics (ONS) announced last month that it was set to move CT onto an accruals basis in advance of Budget 2017. It estimated that this would have a net effect of increasing CT receipts by around £1.4bn, back-dated to the 2013/14 financial year.
The OBR reflected this announcement in its Commentary on the Public Sector Finances Release: September 2016, issued on 21 October. It reiterated the ONS estimate of an increase in government receipts of £1.4bn in 2013/14, and went on to explain how the move to accruals basis would affect the measure I’ve been discussing here (emphasis again added by me):
15. We plan to reflect this methodology in our November forecast, anticipating its implementation by the ONS next year. As we have set out in previous EFOs, this methodology change will remove much of the effect on [Public Sector Net Borrowing] from the July 2015 measure to bring forward payment dates for large companies in 2017-18. The implementation date was moved back two years to 2019-20 in the March 2016 Budget. In our March EFO, we estimated that this measure would increase cash receipts by around £6 billion in 2019-20 and by around £4 billion in 2020-21.
In other words, the anticipated additional cash receipts of £10bn in the years following Brexit will disappear from the government’s accounts.
Of course, the Chancellor is expected to face much bigger problems than this when he presents his Autumn Statement next week, with a potential £100bn “Brexit hole” which could not have been predicted when this story began. But, as flagged by Chris Giles in the Financial Times, this is one element he could have done without.
One might also ask why businesses are being asked to accelerate their CT payments if the impact on the deficit is zero …
[Update following Autumn Statement: as expected, the forecasts in the OBR’s Economic and Fiscal Outlook (EFO) November 2016 include “classification changes” increasing the deficit by over £6bn in 2019/20 and £4bn in 2020/21. The vast bulk of the increase results from removing the effect of this measure. Further details are given in box 4.2 (p.126/7) of the EFO.]