Baker Tilly Partners share their expert views on what businesses can expect in the Year of the Dragon.
While 2011 was full of uncertainty, the Year of the Dragon is known as the luckiest in the Chinese zodiac. It is the year for great deeds, innovative ideas and financial success.
Businesses should be better prepared for this year, as much of the legislation, regulation and taxation due to commence has already been announced. This is a crucial time for businesses, and to be forewarned, is to be forearmed. With this in mind, five Baker Tilly Partners look ahead to the key factors that will affect your business in the Year of the Dragon. They consider future developments in audit, tax and pensions, while also assessing trends in mergers and acquisitions, and recovery and restructuring.
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Understandably, there is concern about the economy in the year ahead, but from an M&A perspective, I am reasonably optimistic. The environment for trade buyers is quite positive. Yes, there is uncertainty, but larger companies are in reasonably good shape. They’ve taken cost out, profitability is at multi-year highs and they have been generating cash. Strong profitability and balance sheets combined with less opportunity for organic growth create a strong driver of potential acquisition activity.
Of course, a deal requires both buyer and seller and we have seen vendors sitting on their hands in the last few years waiting for valuations to improve. However, sellers appear to be adjusting their expectations to the new reality. That means there are now both buyers and sellers in the market. Private equity (PE) houses also remain in investment mode. Much of the money raised during the boom remains available to invest in growing businesses. There are constraints; PE houses are finding it more difficult to secure the debt finance that was part of their acquisition model, but both advisers and investors have adapted to this brave new banking world.
I would expect, therefore, to see a modest rise in M&A activity in 2012 with both trade and PE activity continuing to recover, but slowly. Meanwhile, there are signs of life in the Capital Markets with the Alternative Investment Market (AIM), which suffered heavily during the downturn, just beginning to stir. However, I expect any recovery here to be bumpy.
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Audit and auditors are under scrutiny by regulators both at home and in Europe. While this is, understandably, causing much debate in the profession, at Baker Tilly we have tried to focus on how this might affect our clients.
EU Commissioner, Michel Barnier, has suggested some far-reaching proposals for listed companies. These include mandatory firm rotation and banning firms from providing non-audit services to their audit clients. While some of these proposals are welcome, including facilitating auditors working across Europe, we believe that the increased cost of sourcing non-audit work from another firm and regular re-tendering would be a huge, and hugely unwelcome, burden to businesses.
On the home front, the Competition Commission is looking into many of the same issues as the European Commission, as well as topics such as restrictive bank covenants. At the same time, there are moves by the Government to remove the perceived ‘audit burden’ from a number of businesses. Interestingly, we surveyed over 200 companies and only 34 percent would want to be released from the requirement of having an audit. The real issue facing those who responded is not audit, but excessive financial reporting requirements.
On all of these matters we are keen to ensure that regulators, business leaders and the Government are taking into account companies’ needs. We have shared our survey results with key policy makers and are keen that any changes to audit will help rather than hinder businesses.
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High operating costs, driven by essential items such as fuel and certain raw materials, are a cash pressure that can't be avoided. Businesses operating on narrow profit margins and with products in low demand are unlikely to be able to pass costs down to the end user. Many retailers, for example, will struggle due to a tightly squeezed supply chain and poor consumer confidence, meaning distress on the High Street will continue in 2012.
Across all industries, weaker businesses may have used up the cash reserves necessary for survival and could be using interest-only arrangements with banks or taking up Time To Pay agreements with HM Revenue and Customs. As a result, any increase in creditor pressure may force several businesses over the edge.
For some companies, confidence may be misplaced. What lies in store could be further cost cutting, job losses and, potentially, insolvency. However, a degree of ‘corrective’ fall-out through insolvency may, in fact, act as an effective medicine for the wider economy, freeing up markets for stronger, more competitive businesses to prevail. An increase in insolvencies may also result in opportunities for acquisitive businesses with cash to spend to buy market share or bolt-on operations, thus re-utilising otherwise moribund resources.
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The Chancellor's Autumn Statement and Draft Finance Bill 2012 followed the Government’s aim of making Britain's tax system the most competitive in the G20. The pledge to cut corporation tax from 26 percent to 23 percent was restated, while plans were signalled to soften the Controlled Foreign Companies regulations.
This should mean more benign tax treatment of British multi-nationals with operations overseas. The Chancellor was also keen to encourage innovation. Changes to the R&D tax credit scheme will provide further cash flow savings and make it easier to access; relief will rise to 225 percent of the qualifying R&D spend for small to medium-sized entities and there are also plans for a new scheme to benefit large corporates. In addition, new Patent Box rules will mean profits made from intellectual property will be taxed at 10 percent.
There is help for start-ups through a new Seed Enterprise Investment Scheme, giving 50 percent income tax relief for investors on the first £100,000 invested for funding up to £150,000 per qualifying company. Other EIS relief will remain at 30 percent, but the maximum individual investment was doubled to £1 million and the amount a qualifying company can raise was increased from £2 million to £10 million per annum (subject to EU approval). Businesses in selected enterprise zones will also benefit from 100 percent capital allowances, and the Real Estate Investment Trust scheme has been improved to boost infrastructure investment.
The top rate of income tax, however, stays at 50 percent, while the rate on gains eligible for Entrepreneurs Relief remains at 10 percent.
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The big story this year is the implementation of the Auto-Enrolment Duties that will require all UK businesses to auto-enrol employees into a Qualifying Workplace Pension Scheme (QWPS). These duties will be rolled out over a five-year period, starting with the largest businesses in October. Within a year, all businesses with over 800 employees will be included, and by October 2014, those with over 50 employees will be affected. Linked to this is the introduction of the National Employment Savings Trust (NEST), a low-cost savings scheme for employers to use for their employees. The new duties will provide employers with an administrative challenge, so it is recommended that plans are made early for the auto-enrolment process.
Ultimately, the QWPS will be funded on an eight percent of salary basis: three percent coming from the employer, four percent from the employee and one percent through the tax system. So allowances for this will have to be made in company budgets. Employers that already run a scheme can stick with it or move to a QWPS for some or all of their staff.
Employers that already operate defined contribution schemes will also face increased scrutiny from the Pensions Regulator this year. The Regulator has indicated that it will be looking more closely at the governance of defined contribution schemes and the role of trustees (when the scheme is operated as a trust). In smaller businesses, the trustee board is usually made up of managers, so this will require more management time. Finally, I would expect businesses still running defined benefit schemes to continue to the de-risking process.