Great Budget News For Investors!

Published in Investing on 22 June 2010

Lower corporation tax means higher profits.

As I write, the Chancellor, George Osborne, has just finished his emergency Budget speech, full details of which you can find at HM Treasury.

Although he stressed that this was an 'unavoidable' austerity Budget, 77% of the Chancellor's savings came from cuts to public-sector spending, versus 23% from tax rises. The good news for investors is that he even found room to fund tax cuts for companies...

Lower company taxation equals higher profits

Directors, shareholders and owners of British companies will be particularly pleased by the Chancellor announcing a progressive cut to Corporation Tax. Currently, the standard rate of Corporation Tax for UK companies is 28%, reduced to 21% for small companies.

However, over the next four tax years, and beginning in April 2011, the standard rate of Corporation Tax will be progressively reduced by a percentage point a year, falling to 24% in 2014/15. In effect, this will reduce a company's tax bill by a seventh (14%) four years from now.

Corporation Tax falling year-on-year

The following table shows how this will work in practice, based on a company making a flat profit of £500,000 before tax in each of the next four years:

Tax year

Tax rate (%)

Tax paid (£)

Post-tax profit (£)

2010/1128140,000360,000
2011/1227135,000365,000
2012/1326130,000370,000
2013/1425125,000375,000
2014/1524120,000380,000

As you can see, although this hypothetical company's pre-tax profit is static at £500,000 a year, its post-tax profit rises from £360,000 this tax year to £380,000 by 2014/15. That's an increase of £20,000, or 5.56%.

In addition, the rate of Corporation Tax for small companies (the 'small profits' rate), currently 21%, will be reduced to 20% from next tax year. In effect, this boosts small-company profits by 1/79th, or 1.27%. This will benefit over 850,000 small companies, including my own little business.

Therefore, medium and large companies (but less so mega-multinationals) will gain more from these scheduled Corporation Tax cuts than will the UK's smallest companies. Indeed, the proposed standard rate of Corporation Tax of 24% from 2014/15 is the lowest rate of company taxation ever levied in modern history.

More money for dividends or growth

In short, these tax changes will boost companies' post-tax profits, leaving more money to pay higher dividends or invest for growth. There's no doubt in my mind that this will benefit investors, but it may have no effect on price-earnings ratios (PERs). In other words, while post-tax earnings may rise, investors are unlikely to pay relatively more for these higher earnings via higher PERs.

But what do you think? Post your views in the comments box below...

More from Cliff D'Arcy:

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Comments

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Luniversal 22 Jun 2010 , 4:17pm

Sorry-- knowing the typical FTSE 250 director, I doubt this small and gradual easement will make boards more dividend-minded. Anyway, it's cash flow that guides distribution rates nowadays.

LastChip 22 Jun 2010 , 4:32pm

Maybe, but it's not looking at the big picture.

The headlines will all be about the rise in VAT to 20% from Jan 4th.

One has to question, what if anything, will this do to the turnover of companies and how they will react to the change.

Your article assumes (not unreasonably) stagnant figures, but as we all know, that is not reality.

I suspect (particularly retailers) will stealthily apply this increase between now and Jan, whereby come "sales time", they will all proudly proclaim, they are absorbing the VAT increase. In the meantime, they will have grown profits in the short term. This is no bad thing (other than for the consumer), but is short lived and one has to ask the very serious question; what happens next?

It's certainly not a one way street and I think the answers to a lot of the questions this budget provokes, will not be known for many months to come.

Back2Value 22 Jun 2010 , 11:26pm

I can't really see a valid an argument against this. The only criticism might be that it would be better if it was a bigger cut in a shorter time frame, but given the level of spending cuts, politically that would not be saleable.

Ultimately it'll be good for growth and jobs, and will have the greatest impact when the UK economy is back well on track again - in time for the next general election, no doubt George Osborne will be hoping.

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