Why the government’s company tax cuts won’t help most SMEs grow

There has been a lot of discussion about corporate tax cuts following MYEFO. This article, published in SmartCompany, is one of the more thoughtful ones as it raises the human elements of decision making, uncertainty and confidence as major factors influencing SME owners with respect to their investment decisions.

I’ve been thinking about the merits of a corporate tax cut as a means of creating jobs and growth for some time and now is as good a time as any to offer my two-cents worth.

Let’s start with the federal government’s position. The government state’s on its budget website:

“The Government will support small businesses to become larger businesses by backing them to invest in their growth by reducing their tax rate.”

Okay, so the purpose of the tax cut is for small business to invest in their growth. Where will the funding for this investment come from?

Well, it’s not going to be funded from a tax cut.

Anecdotally, I believe most SME businesses average a pre-tax profit of around 5% of sales. It’s an anecdotal figure, because if I think of the business owners that I help, this is about where their pre-tax profit ends up.

What if we use information that is less anecdotal and more independent? On the Australian Bureau of Statistics website there are a couple of useful tables in the Australian Business Indicators section. Check out Table 6 (income from sales of goods and services, current prices) and Table 9 (company profits before income tax, current prices).

When you combine the information from these two tables you can work out the average pre-tax profit as a percentage of sales for Australian industry. Guess what? In the year to June 2016 it was 5.8%. For the year to June 2015 it was 6.7%. Let’s take the midpoint and call it 6.25%.

Now, let’s take an “average” company turning over $10 million per annum, the level at which the first phase of the government’s proposed tax cuts would apply, and look at what happens if their corporate income tax rate is reduced. As an average company, its pre-tax profit is 6.25% of sales, so $625,000. Prima facie tax at 30% is $187,500. Reduce that by 1.5% and the saving will be $9,375. Reduce it by a further 1% and another $6,250 will be saved, in about 12 months’ time. So, the total saving for this average company is $15,625 if the tax cuts were legislated as proposed.

Growth requires significant amounts of capital; I’ve written about this before and you can find a real life example here. Additional people, infrastructure and working capital all need funding. The tax cuts as proposed are not going to go anywhere near helping an owner of a small or medium size business achieve their growth ambitions.

This is where the broader measures come into play. Things like:

• Education for SME owners to enhance knowledge and instil confidence in making decisions;
• Working with a trusted advisor so business owners receive timely, accurate and relevant information that allows them to track the financial outcomes of their business decisions and make adjustments as needed; and
• A banking and finance system willing and able to fund SME growth.

The last point cannot be underestimated. Take a look at the following graph. It shows trends in annual gross domestic product (GDP), the annual change in business finance and the annual change in the labour force. The information has been sourced from the ABS (GDP and labour force) and the Reserve Bank (business finance). There is a clear correlation between business finance, growth and the changing size of the labour force.

I know all SME business owners would welcome a tax cut. But a tax cut is not the catalyst to make an owner invest in their business for growth. It’s simply not enough and as such, it won’t achieve the government’s objective and will most likely disappear into the business owners’ back pocket.

Michael Stapleton is a founding member of the Association of Virtual CFOs. He operates a Melbourne-based Virtual CFO practice, helping owners of small and mid-size businesses understand the drivers of their cashflow and make financially informed decisions. Find out more about the Association of Virtual CFOs on LinkedIn.