Much has been written about ‘fiscal drag’ in the context of income tax. By freezing personal allowances and tax bands in times of inflation, governments increase tax revenues without raising rates.

The impact is clear: more people pay tax, more taxpayers are pulled into higher rates, and the tax burden rises stealthily over time.

Far less attention is paid to the growing impact of threshold freezes elsewhere within the tax system. Many monetary thresholds introduced years, and in some cases decades ago, remain unchanged despite significant inflation. The result is a different form of fiscal drag. Rather than directly increasing the amount of tax HMRC collects, frozen thresholds are steadily drawing more businesses into complex compliance regimes. These regimes were originally intended to target only the largest groups.

Frozen tax thresholds are pulling more businesses into scope

Inflation changes the real value of monetary thresholds. As a result, rules originally designed for the largest and most sophisticated businesses are gradually capturing a wider range of companies.

The cost for those caught is not necessarily additional tax. Instead, it may be additional complexity, administration, systems investment, governance requirements, professional fees and management time.

The senior accounting officer (SAO) and corporate interest restriction (CIR) regimes provide useful examples.

More mid-market groups are now being caught by SAO

The SAO regime was introduced in 2009 and brings significant additional obligations for those in scope. The regime creates additional notification and reporting obligations and can expose the named SAO to personal penalties. Affected businesses inevitably incur additional professional costs and management time in seeking to help the SAO establish and maintain appropriate tax accounting arrangements. This entails grappling with ever-growing non-statutory guidance (including Guidelines for Compliance and HMRC’s indicators of a low risk taxpayer).

Broadly, the regime applies to qualifying companies and groups with aggregate UK turnover exceeding £200m or aggregate UK balance sheet assets exceeding £2bn. These thresholds have remained unchanged since the regime was introduced. Similar thresholds feature in other governance measures, including requirements to publish a tax strategy and notify HMRC of uncertain tax treatments.

The £200m SAO turnover threshold would now be around £350m if it had increased in line with inflation. This means many mid-market groups are now within scope.

Few would argue against good tax governance, but compliance obligations should be proportionate. The question is whether there has been a deliberate policy decision to widen the regime, or it has simply been easier to leave the thresholds where they are than to uprate them with inflation.

Why more businesses are entering the scope of CIR

The CIR rules came into effect from 1 April 2017 and include a de minimis threshold of £2m of net UK tax-interest expense. This is intended to ensure smaller and less leveraged groups with interest costs below £2m can claim the interest as a tax deduction without undertaking the more complex aspects of the CIR calculations or submitting a CIR return.

However, inflation has significantly reduced the real value of that threshold. The £2m CIR de minimis threshold would now be closer to £2.8m if it had risen in line with inflation. The problem is compounded as interest rates are generally higher now than in 2017.

That difference may appear modest, but it has meaningful practical consequences. Groups that would previously have sat comfortably beneath the de minimis limit are increasingly finding themselves crossing it. Once that happens, the compliance burden can be extensive, covering issues such as:

• Appointing a reporting company
• Computing tax-EBITDA
• Assessing interest capacity
• Considering group ratio elections
• Monitoring carried-forward restrictions and allowances
• Preparing and maintaining supporting documentation
• Filing abbreviated or full returns.

In many cases, businesses complete this entire exercise only to find no restriction applies at all or, in the worst case, there is an interest restriction for a modest, necessary and commercial financing need.

Once you breach, or come close to the limit, managing and optimising tax deductible interest costs can require substantial effort. The result is that many groups face significant compliance work despite having modest finance costs and potentially suffering no restriction.

The growing compliance burden for mid-market businesses

Arguably, the primary effect of maintaining the thresholds outlined above at their original levels is to bring more businesses within the regimes. This will increase compliance time and costs for businesses. In addition, HMRC has greater information and undoubtedly there will be an overall increase in tax paid, whether through increased CIR disallowances or improved controls and processes due to SAO.

The key question is whether the additional time and resource devoted to compliance at this level delivers greater value to the Exchequer than the productivity lost by diverting management attention away from running the business.

The CIR regime provides a good example. Many groups now entering the rules are not necessarily highly leveraged multinational enterprises. Instead, they are often growing commercial businesses whose financing costs have increased due to higher interest rates and inflationary pressures.

Similarly, businesses newly entering SAO and similar corporate governance regimes may not regard themselves as large corporates in the traditional sense. They may simply be companies whose nominal revenues have risen over a prolonged period of inflation.

In addition to governance measures and CIR, there are numerous other thresholds applicable to companies that have been in place for many years without being uprated for inflation. For example:

• Companies must begin paying tax by quarterly instalments once taxable profits exceed £1.5m. The threshold was introduced in 1998 and has not increased since.
• The level of profit at which the carried forward loss restriction begins to apply has been set at £5m since the regime was introduced in 2017.
• Looking more internationally, the €750m turnover threshold for country-by-country reporting has not changed in more than a decade. This figure is now also relevant when assessing transfer pricing documentation requirements, UK tax strategy reporting and the application of the enormously complex Pillar Two rules.

How tax compliance costs affect business growth

Tax policy discussions frequently focus on the direct tax burden. Yet compliance requirements also increase the cost of doing business in the UK.

Every hour spent preparing CIR calculations, documenting and maintaining SAO controls or obtaining specialist advice comes at a cost. It is time and resource that could otherwise support investment, innovation or growth.

These costs can be particularly acute for businesses sitting just above regulatory thresholds. Large multinational groups often have established in-house tax teams and governance frameworks. Mid-sized groups entering these regimes for the first time may face higher incremental costs.

The burden therefore falls most heavily on the very businesses that governments often seek to encourage. It is also worth noting that HMRC’s capacity for enforcement and enquiry is necessarily limited as more and more businesses fall within these regimes.

Why frozen tax thresholds should be reviewed

Whether viewed through the lens of tax policy, economic efficiency, productivity or regulatory fairness, there is a compelling argument that compliance thresholds should not remain fixed indefinitely. Fiscal drag risks becoming not just a mechanism for raising revenue, but for increasing administrative burdens and thereby slowing growth.

One solution would be straightforward: index material tax thresholds annually or review them periodically against inflation. This would preserve the original policy intent.

This would ensure that the SAO regime continues to target genuinely large businesses. It would also allow the CIR de minimis to continue excluding groups whose financing arrangements are relatively modest. The scope of either regime could still be expanded, but the decision would be explicit rather than occurring quietly through inflation or monetary policy changes.

Managing tax compliance as your business grows

In the current political environment, the government has limited levers to raise tax. So, until the productivity gap is addressed, there is little indication that these thresholds will be reviewed.

Growing businesses should therefore monitor their position carefully and take advice well before crossing key thresholds. Compliance is not always cheap, but the cost of non-compliance can be many times greater. Early planning may also allow for opportunities to optimise the position.

If you would like to discuss the issues raised in this article, please contact Shannon Dowdles or your usual RSM contact.

Latest related insights