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 rate (%)
Tax paid (£)
Post-tax profit (£)
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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