Finance Bill: Small and Medium Enterprises – Getting the most out of the months ahead has been saved
Finance Bill: Small and Medium Enterprises – Getting the most out of the months ahead
Background and Economic Context
SMEs dominate the Irish economic landscape, demonstrating the strong entrepreneurial spirit of our people. In overall terms, SMEs account for 99.8% of the total number of business enterprises in the private business economy; they employ 1.06million people, accounting for 68.4% of total employment in the private business economy. As COVID19 receded, recovery was strongest among small businesses with tax receipts from SMEs increasing by 80% compared to 2020. However, having bounced back from the pandemic, challenges such as rising energy, transport and operational costs are putting SMEs under pressure. The SME community are bracing themselves for a difficult working environment if costs continue to increase. Irish business owners are feeling the impact of rising costs, according to the Enterprise Nation Quarterly Small Business Barometer, with 71% of entrepreneurs saying that the crisis would “reduce the profitability” or “severely reduce the profitability” of their businesses this year.
As in previous years, the services sector is projected to account for the highest proportion of corporate insolvencies by the end of Q3 2022 with 195 insolvencies, representing 52% of total insolvencies recorded so far this year and up from 46% in 2021. Budget 2023, announced on 27 September 2022, is set against a backdrop marked by a range of challenges including rising costs, inflationary pressures not seen since the 1970s and a housing market where demand continues to outstrip supply. In the face of such challenges, how can SMEs plan ahead to weather the storm?
Future proofing your business – The three levers to success
Companies encounter many challenges throughout their lifecycle, and during times of volatility and uncertainty, engaging early is key to weathering the storm. Every business is unique and it’s critical for SMEs to understand at what stage in their growth lifecycle it requires support; this will determine the right blend of expertise and engagement. SMEs in their early and growth stages may likely require a more investment-focussed mindset, with a view to expanding their labour force. On the other hand, SMEs experiencing difficulties, may require a greater focus on supports such as tax debt warehousing, tax levers to ensure a healthy cash flow and contingency planning to create a healthier balance sheet for the future. The good news is that for SMEs at all stages of their life cycle, support is there to help them weather the storm.
Taking a holistic approach to all aspects of the business to ensure success is key with focus on three levers: Financing and investment to fund expansion or to enhance financial stability, tax incentives and reliefs for growth and restructuring and insolvency planning.
1. Financing & Investment
Based on a recent SME Credit Demand survey published by the Department of Finance, only 16% of SMEs applied for bank credit in the period from October 2021 to March 2022, with insufficient internal funds being cited by 76% of respondents as the reason for not seeking credit. Notwithstanding the reluctance from some companies to seek credit to expand their business, 61% of SMEs reported profit during 2022 compared to 53% in 2021 while 35% of SMEs have committed funds to invest in energy efficiency over the next year.
While many SMEs traded reasonably well through the Covid-19 period, the short-to medium term outlook is likely to be more challenging given the rising cost of doing business (energy costs, labour costs, input price inflation) and rising interest rates. Notwithstanding the potential economic challenges which lie ahead, opportunities also exist for many businesses and sectors, as evidenced by the continued expansion (be it organic or acquisition led) amongst SMEs in many sectors of the Irish economy. Accordingly, a key consideration for many business owners and managers is therefore the extent to which additional capital and financing can be obtained to support this growth.
While financing and investment remains available from banks as well as the growing universe of alternative debt providers and private equity investors, there is a heightened level of cautiousness from capital providers, and a flight to quality, in the current market. Processes to raise financing and equity investment are taking longer, reflecting an increased level of diligence being undertaken by capital providers, as they seek to understand the resilience of businesses’ financial plans in the face of an increasingly inflationary environment with increased debt servicing costs. The recommendation to any business seeking to raise capital for growth, or to support their financial stability in more challenging periods, is early engagement with your lenders or corporate finance advisors to ensure all options are explored and the interests of shareholders are best protected.
2. Tax incentives and reliefs for growth
Tax reliefs and incentives represent an effective way not only to manage a business’ cash flow but to achieve strategic goals such as hiring and talent retention and sustainability targets. While many companies may view tax purely as an additional cost, tax levers can be critical in addressing a variety of business challenges.
With many SMEs feeling the pressure due to rising energy costs, the introduction of the Temporary Business Energy Support Scheme will be a welcome development. The scheme, details of which are included in the recently issued Finance Bill 2022, will be open to businesses that carry on a Case I/II trade (including self-employed individuals, companies and partnerships), are tax compliant and have experienced a significant increase in their natural gas and electricity costs. The level of support available is calculated at 40% of the amount of the increase in average unit price, with a monthly cap per trade of €10,000, with increases for businesses operating more than one location. The scheme will provide welcome assistance in meeting rising energy bills.
Another core consideration for many SMEs and start-ups is how to attract and retain key talent, with the Key Employee Engagement Programme (KEEP) playing a feature in a company’s hiring strategy. The aim of KEEP is to help smaller firms who cannot compete with larger firms in cash remuneration terms to attract and retain talent in a challenging labour market. The extension of KEEP to the end of 2025, coupled with key technical changes as announced as part of the Budget 2023 package has not been reflected in the Finance Bill 2022 issued on 20 October 2022, but instead will form part of a later Committee stage amendment. We will be watching these developments with interest in the coming weeks, and SMEs who wish to expand their labour force should consider whether KEEP represents an opportunity to compete effectively with the remuneration packages offered by larger companies and multinationals.
A core lever in providing greater cash flow for a business but which remains underutilised in the SME sector is the Research and Development (R&D) Tax Credit. The regime provides for a tax credit equal to 25% of qualifying expenditure on R&D activities. While the credit is firstly offset against current and prior year corporation tax liabilities followed by repayment in three instalments, Finance Bill 2022 changes the repayment option. Going forward, a company will have an option to call for payment of their eligible R&D tax credit or to request for it to be offset against other tax liabilities, and existing caps on the payable element of the credit are being removed. While the amendments do not amend the quantum of credit available, they do amend the manner in which repayment is made and thus may accelerate the cash refund available to companies. R&D can be an expensive process, and figures from the Tax Strategy Group papers released ahead of Budget 2023 suggest that larger companies primarily make up a greater proportion of the costs of the credit. Notwithstanding this, in our experience significant benefit can accrue to medium sized companies who engage in R&D activities, and where cash flow is a concern, serious thought should be given to whether the credit may be availed of.
3. Restructuring and Insolvency Planning
Experience has shown that timely contingency planning and restructuring can address a range of negative economic impacts. Notwithstanding an anticipated increase in corporate insolvency activity in a number of business sectors, there is light at the end of the tunnel for any struggling SMEs in the form of the Small Company Administrative Rescue Process (SCARP). SCARP represents a cost-effective and rapid restructuring process and could be a key lifeline for the survival of struggling SMEs. The process is available to companies that meet two of the following criteria:
a. Turnover less than €12million;
b. Balance sheet total less than €6million
c. Less than 50 employees
For Companies that opt for SCARP to address their financial problems, control is retained by the directors throughout the process, while simultaneously being led by a qualified insolvency practitioner tasked with formulating a rescue plan for the business. And with a 70-day timeline for commencement of the recovery plan, SCARP presents an expedient solution for financially challenged SMEs.
It works by facilitating a binding write down of creditors’ claims, thus providing the subject Company with a healthier balance sheet, which when combined with a cost reduction strategy, delivers a leaner and fitter business model.
In addition to maintaining control during the SCARP process, SCARP also allows Directors & Shareholders to retain control following the successful implementation of the rescue plan. This is in contrast to examinership, where shareholders can sometimes lose majority control following the introduction of investment by external third parties.
One of the key factors that will determine the success of a SCARP process is the approach taken by the creditors, including the Revenue Commissioners. In addition, certain liabilities of state creditors are “excludable” from the process in certain circumstances at the option of the creditor. However, the SCARP cases to date would suggest the Revenue Commissioners have a willingness to positively engage in the process, despite having the option to ‘opt out’ via ‘excludable debt’. In addition, Revenue’s recent announcement to extend warehoused tax debt by an additional 12 months would indicate a constructive approach to the difficulties in the SME sector and may provide an indication of how Revenue will engage with the SCARP process into the future.
When one considers that 95% of Corporate insolvencies in Ireland are foreclosures, either via liquidation or Receivership, there is plenty of opportunity to increase restructuring activity through SCARP and Examinership, but early action by Directors is paramount to ensure that creditors remain supportive of any restructuring plans.
Going forward, the ever changing and challenging business landscape for SMEs will require a move away from the traditionally “siloed” approach to addressing corporate structure, tax and debt. By adopting a multi-disciplinary model focussing on the three levers of proactive insolvency planning, tax incentives and obtaining capital for growth, SMEs can generate significant value and create a plan to future proof their business in the face of imminent economic challenges.
Taking care of business for SMEs with Budget 2023 and the upcoming Finance Bill
Tom Maguire discusses Budget 2023 and Finance Bill 2022 in his latest Business Post column