Boosting British entrepreneurship starts with a better tax system

Time to read: 4 mins

As one of Europe’s most active investors in young, innovative businesses, Octopus knows how tax can affect a business at every stage of its growth. So, we were delighted to work with the All-Party Parliamentary Group (APPG) for Entrepreneurship, and The Entrepreneurs Network, to explore the issue of tax reform in its latest report.

The report focuses on what the APPG considers are the three main factors that directly affect Britain’s business owners, namely:

  • Effectiveness: is the UK’s tax code doing enough to support entrepreneurship?
  • Awareness: are entrepreneurs aware of all the existing tax reliefs at their disposal?
  • Complexity: can the existing administrative burden faced by businesses be simplified?

Is the UK’s tax code doing enough to support entrepreneurship?

As the report explains, each year more than 600,000 new businesses are formed. The entrepreneurs behind those startups will interact with the tax system in a number of ways as their companies mature. It is important to understand the specific needs of entrepreneurs at each stage of business growth.

Accessing finance is key and most entrepreneurs will rely upon tax incentives to attract equity investment initially through SEIS, EIS, and later through Venture Capital Trusts (VCTs). Once they develop a successful business model they may want to scale rapidly. This may involve hiring more workers, investing in new equipment, or renting larger office/retail space.

Startups often run large, up-front trading losses, as they search for a profitable business model. For example, it took five years for Facebook to turn a profit and Twitter only became profitable this year (its twelfth year of trading). The tax system should not penalise firms that prioritise revenue growth over short-term profitability. However, firms running trading losses face an unfavourable tax environment that can impede their access to finance.

“Modern entrepreneurs and founders of the future should be focused on new ideas that drive the economy and create jobs. The tax system can – and should – be designed to encourage enterprise. It must be simple, with a view to boosting startups and scale-ups.”
Colin Clark MP

How can entrepreneurs be made aware of all available tax reliefs?

There is a wide range of support available through the tax system to help businesses grow, but many businesses fail to take full advantage of the support on offer. The report suggests that if awareness of the full range of support on offer was improved, then it would enable more businesses to expand.

The APPG asked nearly 500 business owners about their awareness of eight major tax reliefs (Annual Investment Allowance, R&D Tax Credit, Patent Box, Enterprise Investment Scheme, Seed Enterprise Investment Scheme, Entrepreneurs’ Relief, Employment Allowance and Business Rates Relief). Over a third of business owners hadn’t heard of either the Employment Allowance or the Patent Box, while only one relief (the R&D Tax Credit) had awareness of over 80%.

One of the report’s suggestions was for HMRC to include explanations on different tax reliefs within all its communications with small businesses. Uptake could then be tracked and measured.

How can we simplify the tax burden for small businesses?

For new businesses likely to face uncertain revenues and difficulties gaining access to finance, cash-flow really is king. But the collection of Corporation Tax and National Insurance Contributions can create major cash-flow issues. For firms, who may have difficulty accessing credit, additional flexibility to pay either of these taxes would smooth over cash-flow issues that can act as a constraint on hiring or expansion.

For example, currently, SMEs with profits of £1.5 million or more are required to forecast their taxable profits each quarter. Increasing this allowance to £5 million per annum, as the Institute of Directors recommends, would have no long-term impact on the public finances (there would be an upfront cost), but it would allow medium-sized businesses to better manage their cash-flow and avoid making advance payment to HMRC when they have opportunities to expand their business.

SMEs in their first three years of operation should be granted additional flexibility to make quarterly rather than monthly Employers’ National Insurance Contributions. This would also have no long-term impact on the public finances, but it will provide valuable support to businesses who struggle to access finance due to lacking a track record or collateral. The flexibility should be time-limited to recognise that once firms have a track record of successful operation, they are better able to access finance and require less flexibility.

While the UK remains one of the best places in Europe to start a new business, with a well-developed ecosystem of venture capital firms and angel investors, startups and scale-up still face difficulties in accessing finance. As the 2018 Octopus High Growth Small Business Report highlighted, if just 1% per cent of the capital invested in Stocks and Shares ISAs was invested in small, unlisted firms, this would unlock £3.15 billion of extra investment for high growth small businesses.

Summary

At a time when Britain is preparing to exit the European Union, and with the global market for entrepreneurs getting ever more competitive, it is absolutely vital that our tax system can compete with those of our rivals in Europe and beyond, and that it keeps up with the challenges and opportunities that new innovation brings. The APPG’s report on tax reform has highlighted how important a fit-for-purpose tax system is for creating the right conditions for entrepreneurs to flourish. Down the years, Octopus has invested in over 500 early stage businesses, and we see first-hand the administrative and, at times, bureaucratic burdens entrepreneurs face. The more we can do to reduce these, along with making the existing tax reliefs more accessible – and more widely understood – the better.

Download a copy of the report

Author
Octopus Group
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