Business Studies – 6.1.2 Effects of government policy | e-Consult

Introduction: A tax credit is a direct reduction in the amount of tax a business owes. Government incentives like tax credits are designed to encourage specific business behaviours, such as investment in technology. This answer will explain how a tax credit for technology investment can affect a business's profit, providing an example to illustrate the point.

How a Tax Credit Works: A tax credit reduces the amount of tax payable. For example, if a business has a profit of £100,000 and owes £20,000 in corporation tax, a tax credit of £5,000 would reduce the tax liability to £15,000. This directly increases the business's profit.

Example: Consider a software development company. The company invests £50,000 in new software development equipment. The government offers a 10% tax credit on the cost of this equipment. This means the company receives a tax credit of £5,000 (10% of £50,000).

Calculations:

• Profit Before Tax: £100,000
• Tax Liability (20%): £20,000
• Tax Credit: £5,000
• Profit After Tax: £100,000 - £20,000 + £5,000 = £85,000

Impact on Profit: The tax credit increases the business's profit from £80,000 to £85,000. This makes the investment in new technology more financially attractive. It improves the company's cash flow and allows for further investment or expansion.

Conclusion: Tax credits can significantly improve a business's profitability by reducing its tax burden on specific investments. This incentivizes businesses to undertake activities that are deemed beneficial to the economy, such as investing in new technology or research and development.