The rate of inflation is of constant concern for business owners and consumers alike as the cost of living steadily increases.
However, businesses may be feeling more pressure as a result of inflation due to fiscal drag – the occurrence where a financial threshold is crossed due to inflation rather than any real-world growth.
Many of the important tax thresholds are frozen and unlikely to change soon, so getting smarter with financial forecasting is the only way to minimise the impact of fiscal drag.
Corporation Tax is likely the place where most businesses will feel the effect of fiscal drag.
Since 2023, the Corporation Tax thresholds have been frozen, and the relief window on profits between £50,000 and £250,000 has remained unchanged since it was established.
A marginal relief is applied to earnings within this window, but those earnings are still subject to the full rate of 25 per cent Corporation Tax.
The relief is welcome, but fiscal drag is hindering the ability of the relief to be truly effective.
As the thresholds have not risen alongside inflation, businesses are being pushed into higher rates of Corporation Tax than is befitting of their profitability.
For small businesses that are pushed across the £50,000 threshold, they become subject to the full rate of Corporation Tax rather than the 19 per cent they would otherwise pay.
Similarly, larger businesses are being pushed out of the relief window as they cross the £250,000 threshold and are subject to the full rate of Corporation Tax without relief.
This is despite the real-world value and profits of these companies not changing in many cases.
VAT is also a place where businesses may find fiscal drag causing problems.
In 2024, the VAT threshold changed from £85,000 to £90,000 but inflation has seen businesses cross the threshold regardless.
Crossing this threshold results in additional administrative burdens coupled with the financial obligations, yet it is untethered from real-world profitability increases that would typically balance out such stress.
Developing an awareness of the impact of fiscal drag is the best way for businesses to begin mitigating its impact.
Financial forecasting can highlight when and how fiscal drag will impact a business while also outlining possible methods of sustaining financial health regardless.
Professional accounting advice is typically the key to mitigating fiscal drag.
Tax-efficient investments and five-year forecasts are essential tools to boost a business’s financial health.
By keeping a close eye on financial performance, businesses can adapt to any challenges that arise.
Clear and open communication with those involved in the business’s finances can also be an important step in making smart decisions that will adapt to the challenges imposed by fiscal drag.
Our team can help you deal with fiscal drag so that your business can continue to grow.
Don’t let fiscal drag get you down. Speak to our team today!
