As all eyes watch the rate of inflation for the impact that it will have on a tumultuous economy, there is another reason to be concerned by the steady increase.
Fiscal drag, the occurrence where a financial threshold is crossed due to inflation rather than any real-world growth, is on the rise for businesses and individuals alike.
With many important tax thresholds frozen, there is an increasing incentive to get smarter with financial forecasting to fight fiscal drag.
What are the main areas affected by fiscal drag?
One of the main contributors to fiscal drag is Corporation Tax.
The Corporation Tax thresholds have been frozen since 2023, with a relief window on profits between £50,000 and £250,000 remaining unchanged.
Earnings within this window are still subject to the full rate of 25 per cent Corporation Tax, but this is reduced by a marginal relief.
While the relief has been welcomed by growing businesses, the fact that it has not increased alongside inflation is a cause of concern for many.
Small businesses are being pushed past the £50,000 threshold, meaning that they have to contend with the relief window where previously they paid the 19 per cent reduced rate.
On the other end of the spectrum, growing businesses may find that they are pushed out of the relief window if their profits are above £250,000.
In essence, a company could be making the same real-world money as they were last year, but would now be subject to higher rates of tax.
This is also true regarding the VAT threshold.
While the VAT threshold did change from £85,000 to £90,000 in 2024, inflation has still seen many sole traders and small retailers pushed above the line.
This has caused additional tax considerations and administrative duties to befall businesses that do not benefit from a real-world boost in profitability.
What can businesses do about fiscal drag?
Being aware of fiscal drag is the first step in handling it.
This awareness can form part of financial forecasting as businesses factor in the increased tax burdens that may come their way as fiscal drag pulls them across thresholds.
Seeking professional accounting advice is essential to mitigate the impact of fiscal drag.
Five-year cash flow forecasting and tax efficient investments are key tools that can be leveraged by businesses to sustain better financial health going forward.
The closer businesses monitor their financial performance, the better they will be able to adapt to challenges as they arise.
This needs to be coupled with transparent, dynamic communication so that everyone involved in decision-making within a business is aware of what could leave a business vulnerable to fiscal drag.
Our team are on hand to help you navigate this current time of economic turbulence and keep your business growing.
Don’t get dragged down by financial woes. Speak to our team today!
